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Agency I. Forms of Business Organizations: a.

Sole Proprietorship: you are liable for everything on your own: you are responsible for raising capital, if anyone is injured or torts or employees, paying bills, personally liable to creditors i. Agency Law b. General Partnership: more stable than agency; firm- form of business relation that has a temporal dimension, social identity & a separate pool of business assets i. Partnership & Agency Law c. Corporations: most stable i. Corporate & Agency Law II. Business Organization Theory: a. Coase: there are firms b/c of transaction costs; firms come into existence when costs of command & control are less than market transaction costs; firms exist when it is more efficient for a business entity to organize around a command function b. Costs associated with command & control structures (i.e. organization in firms) i. Agency Costs (to the extent that the incentives of the agent differ from the incentives of the principal- Berle & Means believe the market for corporate control in a publicly held corporation will eliminate agency costs 1. Monitoring: costs to ensure agency loyalty & making sure the agent is doing what he is supposed to do 2. Bonding: Costs that agents spend to show owners their reliability; costs of developing mechanisms to make the agent follow the principals objectives 3. Residual Loss: costs that are left from differences of interest after monitoring and bonding casts are occurred ii. Agents have less incentive to work as hard for you as you would iii. Resolution: bond their interests to your interests (make them care about the quality of their output) OR oversight III. Section 1 of RS Agency: Agency is a fiduciary relationship that arises from: a. The manifestation of consent by Principal (P) to Agent (A) that A shall act i. On Ps behalf, and ii. Subject to Ps control, and iii. As consent so to act b. PAT Triangle: Core of the agency relationship: Agent can bind Principal to a Third party c. Parties cannot disclaim agency by formal consent IV. Generally: a. Agency is terminable at will- can be ended at any time by either P or A b. May be able to imply a term V. Jenson Farms v. Cargill: Farmers (T) are suing Cargill (P) on the theory that the local grain operator who failed to pay T is just an agent of P; A was financed by P and they entered into a security agreement where P would loan them money for working capital (Debtor/creditor relationship) a. Focus of inquiry: Level of control- Did P control A? If so liability i. Residual risk bearing: proxy for control; have all the risk of enterprise as opposed to regular lender who only has some risk ii. Need to show they were exerting the wrong kind of control b. Court looked at the following factors and found an agency relationship, holding P liable for contracts made by A acting on Ps behalf: i. Constant recommendations over the phone; right of first refusal on grain; inability to enter into mortgages, purchase stock or pay dividends w/o approval; right of entry onto the premises to do periodic checks and audits; correspondence and criticisms regarding the finances, officers, salaries and inventories; determination that they needed strong paternal guidance; provision of drafts and forms where their name was imprinted; financing all the purchasing of grain & operating expenses; power to discontinue financing the operation; amount of risk incurred by P ii. Typically party bearing the risk is the party in control

1. Risk here: risk of fluctuation of price of grain Agency: Tort Issues I. Vicarious Liability: a master is subject to liability for the torts of his servants committed while acting in the scope of their employment (RS 219-1) a. Employee v. Independent contractor i. A Master-servant relationship exists where the servant has agreed to (1) work on behalf of the master + (2) to be subject to masters control of the way the job is performed ii. 2 Types of Independent Contractors: not subject to physical control- P cotrols what, not how 1. Agent: one who has agreed to act on behalf of the principal, but not subject to principals control over how the result is accomplished 2. Non-agent: One who operates independently and simply enters into arms length transactions w/others b. P is liable for torts & contracts: if employee (master/servant) done w/in scope of employment i. P is liable for contracts but not torts: If non-employee agent (agent- ind. Contractor) ii. P is NOT liable in agency law: If non agent independent contractor c. P is not liable: if not w/in scope of employee; in agency law (ind. Contractor (nonagent) or nonagent service provider) II. RS 228: conduct of servant is w/in scope of employment, if, but only if, it is actuated at least in part by a purpose to serve the master III. Analysis of Tort liability in Agency Context: a. Is there an agency relationship between P & A? b. Is A Ps servant or independent contractor? IV. Policy: Least cost avoiders wants P to prevent harms in future by internalizing costs V. Gas Station Cases a. Humble Oil: Humble employee negligently injured plaintiff and Humble was sued as P; Humble argued that station was run by an independent contractor so Humble was not liable for the owner or his employees negligence i. Inquiry on control: Humble controlled operations of station; owned station itself; products were sold there; operating agreement required station to do anything Humble required ii. Held: Independent contractor who ran the station was Humbles servant so Humble is liable EVEN THOUGH the k repudiated any control over stations employees b. Sun Oil: Similar to Humble but Sun Oil advised the operation but Barone was not obligated to follow it; B bore the risk of profit/loss i. Held: No right to control; no master/servant relationship, so Sun Oil is not liable for Bs employees negligence 1. Does not control daily activities physical control: tells them HOW to do their job, not just WHAT they do c. Humble v. Sun Oil: Important Factors of Control i. Rent: Volume based v. volume-based but max. & min. ii. Utility bills: Humble paid v. ? iii. Reports: As required v. none iv. Hours of operation: Humble Set v. B set v. Subordinates: operator hires in both vi. Appearance: ? v. Sun Oil logos (the type of control Sun is seeking to insure is protecting intellectual propert) vii. Duration of P to Cancel: at will v. 30 day notice viii. Supervision: K requires perform duties as specified (command requirement) v. Sun make recommendations but B is free to ignore VI. Franchise Agreements: Franchiser supplies name, etc. & franchisee enjoys right to profit & runs risk of lossfranchise k does not insulate parties from agency relationship if the K so regulates the activities of the franchise as to vest the franchisor w/control w/in the definition of agency, the relationship exists even if the parties expressly deny it a. Courts construe franchisor liability narrowly- need to show control over the instrumentality that caused the harm

b. Murphy v. Holiday Inn: HI sells logo- licensing relationship off intellectual propertypurpose of K was solely standardization i. Facts: P slipped & fell in HI. B owned hotel. HI not liable ii. Control analysis: HI did not have the right to control the methods or detail or doing the work so there was no P-A or M-S relationship. 1. Residual Risk bearer: makes the decisions that control if the business will make more or less moneyif not, then you are not the least cost avoider & then no liability 2. No control over the part of the business that generated the injury (daily maintenance) c. Miller v. McDonalds: P buys a burger & bites a stone; K expressly disclaimed agency relationship but that is not enough; P went to the restaurant under the assumption that D owned, controlled & managed it i. Instrumentality that cause the injury: Making a big Mac D controls that (D enforced precise methods & retained power to cancel the K) ii. Right to control test: if the franchise agreement goes beyond setting standards & allocates the right to exercise control over the daily operations of the franchise, there is an agency relationship iii. Apparent Agency (RSA 267): one who represents that another is his servant or other agent & causes a 3rd person justifiably to rely upon the care or skill of such apparent agency is subject to liability to the 3rd person for harm caused by lack of care or skill of the 1 appearing to be an agent as if he were such 1. Problems: has the potential to make every franchisee into servant of franchisor; McDs would open less stores b/c they need the control over them; without the control they will hurt brand image 2. Potential solution: very visible signage so no justifiable reliance- might not be enough- need to allocate costs to injuries that are predictable in the business iv. Issue: Did the putative principal hold the 3rd party out as an agent & did P rely on that holding out? 1. Yes: McDs needs uniformity so public would think they were the owner v. Indemnification clause: says franchisee will pay franchisor for any problems BUT franchisees are judgment proof 1. Solution: Contractual means of allocating liability INSURANCE (require franchisee to buy or you buy & charge them) d. Ways to minimize franchisor liability for torts: i. Contractual disclaimer: Make clear that franchisee is IC ii. No holding out as agent: In contract, provide affirmative notice of relationshipindependently owned & operated by on everything iii. Indemnification: If vicarious liability, A will pay back P what is paid. 1. So K should say: Franchisee will indemnify franchisor against all claims as a result of them being found as an agent iv. Insurance: Purchase insurance for franchisee VII. Foreseeability Test: test of liability is whether employees conduct was foreseeable to the employer (broad) & some kind of general harm relates to employers demands a. Ira Bushey v. US: drydock sank from drunk seaman; no doubt master/servant relationship but the acts of the employee were NOT in the scope of his employment i. Analysis: Court did not care if the actions were motivated by his desire to serve the employer; instead what should the US have foreseen? 1. Foreseeable that sailors coming back and forth from ship would cause damage- arises from specific relationship, not general environment, b/c government insisted they have access to drydock 2. A business cannot disclaim responsibility for accidents which may be said to be characteristic of its activities: a. Risk characteristically attendant upon operation of the ship b. Human nature c. Conduct not so unforeseeable

d. As long as within course of employment ii. RS third rejects foreseeability rule VIII. Intentional Torts- motive/intent of actor can make employer liable; SERIOUS CRIMES are outside the scope or if the use of force is so unexpected a. Manning v. Grimsley: pitcher throws ball at heckler intentionally i. Holding: Where a P seeks to recover damages from an employer resulting from employees assault, he must show that the assault was in response to the Ps conduct which was presently interfering w/the employees ability to perform his duties successfully. 1. Heckler was interfering w/pitchers ability to pitch the game so team was liability 2. Question is Scope of Employment 3. Pitcher is liable as well IX. Independent Contractors: Contracting party is not liable for negligent acts of IC in the performance of the K unless: a. P retains control (really disguised as M/S relationship) b. P engages an incompetent contractor (ex. No insurance) c. Nuisance per se The activity is very hazardous d. Majestic Realty v. Toti: Demolition of buildings that were not safe enough; was an IC relationship- no control over wrecking ball i. Analysis: this activity is so inherently dangerous activity so the company is liable for the actions of the independent contractor b/c they cannot delegate their liability to another party 1. Holding: Contractor cannot satisfy judgment and so they should have hired someone with insurance Principals Liability in Contract I. Rest. 144: a principal is subject to liability upon Ks made by an agent acting w/in his authority if made in proper form and w/the understanding that the principal is a party a. If there is authority P is always liable for the agent II. Types of Authority a. Actual Express Authority: (AEA) P tells A to do x, A does x, so P is liable for consequences to T of x, even if T doesnt know A is acting for P i. Manifestation of consent from P to A- express delegation of authority is actual authority ii. Not only kind: would slow things down for A; inefficient b. Actual Implied Authority: (AIA): P tells A to do x, but in order to carry out x, A takes other (not explicitly stated) actions (y) in order to do x, so P is bound to T for y this is actual authority (so manifestation of consent) i. Circumstantially proven by what the agent believed- the agent thought he had the authority to do it b/c he thought his authority included that 1. P actually intended A to possess authority & includes such powers as are practically necessary to carry out her duties 2. KEY: signal P to A. If it is P to A, then its AEA and AIA. 3. actual authority circumstantially proven c. Apparent Authority: (AA): Signal that is received by the 3rd party- think about what the 3rd party heard or believed. An A has authority sufficient to bind the P when the A acts in such a manner that would lead a reasonable prudent person to suppose that the A had the authority he purports to exercise i. KEY: signal received by T 1. T must reasonably believe & rely on the signals- doing so binds P 2. If P authorizes A to make such statements, then P will be liable to T under AA for statements made by A (Ampex) ii. Not actual authority, but holding out- appearances & communications between P & T iii. Agent has the AA to do those things which are usual and proper to the conduct of the business which he is employed to conduct iv. Policy Arguments: 1. Protects T who relies on manifestations of authority that dont exist but are manifested to her by P





2. Externality: these manifestations create liabilities on Ts and to avoid externality on T, need to make P liable a. P is least cost avoider: can make clear no agency exists d. Inherent Authority: (IA): Actual authority which the P intended the A to possess and includes such powers as are practically necessary to carry out the duties delegated (catchall category) i. Undisclosed Principal: idea is that 3rd party has no reason to believe the A is not authorized to do what he is doing & the P is getting a benefit from the A so they should bear the risk of him acting outside the scope of his authority ii. P is responsible for some acts of A which, while unauthorized, are close to that which the A is authorized to do iii. Where there MAY be IA, there is usually overlap w/other categories (so ct will try to decide case on other categories) iv. Paradigm case: the undisclosed P v. Court looks at As direct & indirect manifestations and determined if T could have reasonably believed that A had the authority to conduct the act in question Mill St. Church v. Hogan: a. Facts: Church asks Bill to paint the building. In past, B has been allowed to hire his brother Sam to help. He needed help so asked S. S broke leg during job. b. Holding: B had Implied Authority to hire S so S was w/in employment of church when he was injured. So S can recover from church because B has AIA to hire him. i. Apparent Authority: Course of prior dealings led S to think B had authority Dweck v. Nasser: anymore? a. Facts: N replaces D and D sues for wrongful termination. Question of authority to settle. b. Implied authority: Set of past dealings between attnys led Ns attny to believe he had the auth. To make the deal c. Courts presumption sets up burden on N to say to T that lawyer does not have authority) i. Concern of where to place burden: 3rd party to confirm or principal to disclose 370 Leasing v. Ampex, p. 23: Salesman accepted K- is it binding? a. Facts: 370 (T) wants damages for Ampex (P) for breach of K to sell computer memories. Joyce (T) at 370 executed the K but Ampex never signed it. Sales rep (A) from Ampex wrote letter confirming K. b. Holding: Sales rep had apparent authority to accept Joyces offer on behalf of Ampex (letter can reasonably be interpreted as acceptance). i. No actual implied authority or actual express. 1. Limiting Instructions: Then A does not have ANY type of actual authority a. Here: known in Ampex that only certain people had authority to bind company i. Manifestation of non-consent: P expressly limited people to enter into a K like this ii. Apparent Authority: Only view that matters is Joyce 1. Relevant signals: a. Reasonable for T to assume salesman has authority to bind b. Joyce had asked for A and Ampex could have told her A was not authority but did not c. Nothing in K said A could not sign d. Course of Dealings: A suggested he could act for Ampex 2. Secret limiting instructions: Cannot affect apparent authority b/c not known by Tonly inside Ampex iii. Ampex could have protected itself in K: write in that only certain officers of Ampex had authority to sign on its behalf 1. Better to put burden on Joyce? More effort, Ampex is least cost avoider; Ampex has form K (so can add line for authority) Inherent Agency: a. Watteau v. Fenwick: Humble is Ds manager. Humble had no authority to buy any goods for business except ales and water. This action was brought to recover for cigars and Bovril.

i. Holding: An undisclosed P is liable for acts of an A done on his account if usual or necessary in such transactions, although forbidden by P 1. Secret Limiting Instructions: He could not have believed he had authority but sellers did not know there was a P so no argument on signals received from P. a. Secret instructions + undisclosed P 2. Burden is NOT on T: would be more expensive to operate pubs- should not be required to scrutinize too carefully the mandates of permanent or semi-perm As who do no more than is usually done by As in similar position) ii. What is normal, customary course of business? Subjective to ct 1. If it is normal to sell Bovril to pub owners, they can just sell b/c it is implied in the type of business VII. Ratification: affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally authorized by him (RS 82) a. Requires acceptance of the results of the act w/an intent to ratify & with full knowledge of all the material circumstances b. Ratification creates the agency relationship that did no exist at the time of the act i. Affirmation can be express or implied c. Botticello v. Stefanovicz: Husband & wife own property as tenants in common. H enters into K to sell property but he never told anyone that he was acting as his wife or her agent. P sues for spec. perf. i. Holding: you do not automatically create agency relationship by marriage. 1. Even though W accepted rent, she did not have FULL knowledge of all material circumstances- she thought only rent, not purchase. 2. B/c H did not purport to be acting on Ws behalf, W would need to ratify otherwise she is not bound by K. VIII. Agency by Estoppel: an agency created by operation of law & established by Ps actions that would reasonably lead a T to conclude that agency exists. a. To prove agency by estoppel, T must allege: i. Acts or omissions by P, either intentional or negligent, which create an appearance of authority in the purported A ii. T reasonably and in good faith acts in reliance on such appearance of authority iii. T changed her position in reliance upon the appearance of authority b. Hoddeson v. Koos: Imposter salesman at a furniture store took Ps money & said would deliver furniture. Store said they did not have order and did not know salesman (P did not know A existed- no agency authority, no ratification, so can only succeed on estoppel) i. Store created the risk: had control over sales floor; least cost avoider IX. Atlantic Salmon v. Curran: Shady fish salesman a. Facts: Salmonor and AS are owed money for salmon sold to Ds company. Ds company is not incorporated, so D cannot be personally liable. But D signed the salmon K with inc. P would have been liable here but they were judgment proof. b. Holding: It is the duty of the agent, if he wants to avoid personal liability on a K entered into by him on behalf of his P, to disclose that he was acting in a representative capacity & the identity of the P. i. Not AS duty to seek out the identity of Ds P, but instead Ds obligation to fully reveal it. It is not sufficient that AS may have been able to search ACTUAL KNOWLEDGE is the test. ii. RS 321: Unless otherwise agreed, a person purporting to make a K with another for a partially disclosed or undisclosed P is a party to the K agent is liable personally c. Rationale: T should know who they are contracting with for knowledge if they will be likely to be paid Agency: Fiduciary Duties owed to P by A duty of care, utmost good faith & loyalty I. An agent is a fiduciary of her principal: A has FD to act loyally for the Ps benefit in all matters connected with the agency relationship a. Agent has a duty not to get material benefit from a third party in connection with transactions conducted or actions taken on behalf of the P or through the As use of the Ps position b. Agent has a duty to not deal with the P on behalf of an adverse party in relation to a transaction connected with the agency relationship unless there is fair dealing & full disclosure

c. If the P consents, then no breach of duty d. Duty of care: act in good faith as a reasonable person would (RS 379) i. Ordinary prudent person in same circumstances e. Loyalty: RS 388 i. Secret Profits: 1. From transactions with principal (RS 389) 2. From use of Position (Reading) ii. Usurping Business opportunity from Principal (Singer) iii. Grabbing & Leaving (Town & Country) II. Secret Profit Rule: agent violates his FD is he makes secret profits that take money away from the principal a. Allocates disclosure burden to A they are allowed to make disclosed profits b. Reading v. Regem: Soldier in Uniform: i. Facts: Lorry is used to transport illegal materials. British military did not stop him because it looked like a military truck & Sergeant was seated in passenger seat w/uniform on. ii. Holding: the mere fact that his service gave him the opportunity for getting $ does not entitle the British to it. BUT him wearing the uniform as the sole cause of him getting $ and getting dishonestly- this is an advantage that he is not allowed so British can get it 1. Hypos: a. Sergeant discharged from army before sitting there not an agent but illegal in other ways b. Someone bought uniform Brits would get money b/c illegal c. Military hero goes on leave & gets money from PR money is from something he did, not his uniform i. Same if CEO of company and writes book 2. If A must account to P for profits depends on whether the agency afforded him the opportunity to make the profits OR the agents specialness provided him with the opportunity to make money a. Hypos: i. If Mike Jordan opens steakhouse & makes profits b/c of his name, it is not b/c is he a Chicago Bull ii. If Harvard professor is hired for expert testimony, Harvard gets $ if he is hired solely b/c he is professor there, but he gets money is he is an expert III. Business Opportunity Rule: When a business opportunity arises, Agents breach FD by acting adversely to the interest of the P by serving or acquiring his own private interests must disclose all facts a. General Automotive v. Singer: Great mechanic steals customers i. Facts: Singer was a great mechanic for GE. Sometimes jobs came in that Singer thought the company could not do, so he gave the work to another shop & made money off it. But he did not tell GE he was acting as a broker for other corps. ii. Holding: In his FD to GE, Singer is bound to exercise good faith & loyalty to not act adversely to the interests of the co. by serving or acquiring any private interests of his own. He had a duty to disclose to GE all the facts & by failing to disclose & receiving secret profits, he violated his FD. So liable for amount of money he made iii. Default rule: parties can choose the rule- here his employment K prevented him from engaging in this conduct- Singer could have bargained with GE before IV. Grabbing & Leaving Rule: Violates FD if you steal trade secrets of P. a. Town & Country: Cleaning company & some employees broke away to start their own company. i. Facts: Employees only solicited business from clients of former employer. ii. Holding; The trade secret was list of Ps customers. P had screened them extensively. 1. Employees should have invested their own search costs. Standard IP concerns- want people to invest in the product. 2. Also- could have called old clients and say Ill do it for less, how much did the other place charge. 1) Recap i Set of rules operating under

Agent liable to third party for contract made for principal (i) Agent not liable to third party if Principal is fully disclosed to third party (ii) Agent may be liable on a Contract if Principal is only partially disclosed 1. Agent should reveal (NB: Third party has no obligation to ask) a. That he is in action on behalf of principal b. Identity of Principal Agent may be liable to Principal (i) Violation of limiting instructions, breach of duty, etc (ii) Restatement Section 160, 383, 399, 400 Principal is liable to third party for agents contracts when there is authority PARTNERSHIP Partnership: Formation I. Partnership: an association of 2 or more persons to carry on as co-owners of a business for profit (UPA 6-1) a. Splitting profit AND know they are splitting it i. Profit sharing creates presumption of partnership even if they do not intend to be partners b. Can become partners just by acting like partners c. Partners are personally liable for the obligations of the partnership (torts, breaches of FD, Ks,) (UPA 15) d. UPA 7.4: Prima Facie Case of partnership: receiving net profits, unless net returns are interest payments, wages, rent, etc. i. 7.3: Receiving a share of gross returns (revenues) does not indicate a partnership 1. PROFITS v. REVENUES is important e. Four basic facts of partnerships: i. All owners (partners) are also general agents of the partnership ii. All partners share equally in control, unless they agree otherwise iii. All partners are liable as principals iv. All general partners are j& s liable for debts of the business if 1 partner does not something wrong, the whole partnership is held laible II. Two Partnership Theories: a. Partnership in Fact: Actual partnership is formed- like actual authority, can be circumstantially proven b. Partnership By Estoppel: Like apparent authority III. A partnership exists in law & determined by the following factors, not just by what the parties title themselves: a. Intention of parties: i. Written agreements or statements by parties adjectives to describe the parties & rights and obligations gives to them ii. Agreement: Necessary to form a partnership but can be express or implied. 1. Written is not determinative intention controls- need meeting of the minds to ACT like partners, not just legal partnership b. Right to share profits c. Obligation to share losses: focus is whether parties are residual risk bearers d. Ownership & control of the partnership property & business e. Power of administration & management f. Conduct of parties towards 3rd parties g. Rights of the parties on dissolution IV. Fenwick v. UCC: Receptionist names partner a. Facts: Chesire was employed as cashier and receptionist. She requested a raise so her and Fenwick entered into partnership agreement where Fenwick retained control but Chesire would get 20% of the profits if business warrants aka discretionary. b. Holding: No partnership. Agreement was just to provide a method of compensation. Chesire had no authority or control, was not subject to losses (risk), and was not held out as a partner. c. Rationale: Essential element for co-ownership was lacking. So residual risk bearing- she will not profit or suffer frm the business

i. Profit: mostly to F; Loss: all F; Control: All F; Rights upon dissolution: All F V. Partners v. Lenders: (UPA 15) partners are j & personally liable for obligations of partnership v. Lenders: non-partner lenders have priority as creditors a. UPA 40: Loans by PARTNERS to the partnership are subordinated to the loans of creditors other than parties i. Creditors can go after each partner for their proportion of obligation ii. So partnership creditors get first priority to partnership assets & individual creditors get first priority for individual assets 1. Partnership creditors have second priority to individual assets & individual creditors have 2nd priority to partnership assets (UPA 40h-i) iii. RUPA 807a: Partnership creditors get first priority to individual and partnership assets along & individual creditors have first priority to individual assets but second to partnership assets? b. RUPA 306: partners j&s liable on partnership torts & ks BUT must exhaust business assets before pursuing personal assets c. Martin v. Peyton: Creditors had a lot of control i. Facts: Ds loan the company $2.5 mil of securities that was to be returned to them through a % of the companys earnings ii. Issue: Do the conditions of the loan turn them into partners? iii. Holding: Lenders are not partners. Just looking to secure their interests as lenders. Look to see if D is residual risk bearer: 1. Ds return on investment: 40% profits; Collar (min & max) to get 40% of profits for a term until the loan is paid off but option to buy up to get 50% equity interest in firm; D continue to collect dividends on securities 2. Ds Control Rights: consult on important matters (unusual for lender); inspect books (ok for lender); veto on certain investments (unusual); life insurance on main P (ok but excessive); no loans & fixed draw rights by other law firm partners (normal for borrowers); pre-signed resignations iv. Court looks to totality of relationship: Although excessive control, not enough to be partnersjust exercising good caution with investment VI. Partnership by Estoppel: creates liability to third parties who (justifiably) rely upon representations that partnership exists. a. Young v. Jones: i. Facts: PW-Bahamas had issued audit letter about the bank. Ps say they deposited money b/c of that letter. The letterhead of PW-Bahamas just said Price Waterhouse. Want to recover from PW-US for money that was lost. ii. Holding: Ds documents show that PW-Bah and PW-US are separately organized so no partnership. Also not Part. By Est. b/c no evidence the credit was extended on the basis of any representation of a partnership.- no RELIANCE- instead looks like a franchise iii. Griffith thinks this is a problem: where is the representation coming from? Brochure? Court emphasizes reliance instead Partnership: Fiduciary Duty I. Basic Fiduciary Duties: a. A partner must account for any profits acquired in a manner injurious to the interest of the partnership, such as commissions or purchases on the sale of partnership property b. A partner cannot, w/o the consent of the other partners, acquire for himself a partnership asset, nor may be diverted to his own use a partnership opportunity c. He must not compete w/the partnership w/in the scope of the business II. Fiduciary duty: Members of a partnership, or joint adventurers, owe a duty of loyalty to each other and must disclose opportunities that arise in order for both to have an equal chance to take advantage of it owe full disclosure a. Meinhard v. Salmon: (Cardozo- duty of loyalty) i. Facts: Gerry leased Salmon a Hotel for 20 yrs. Salmon entered into agreement w/Meinhard for the funds. M was to pay S the money to manage & operate the property. S was to pay M 40% of profits for the 1st 5 yrs and 50% after that. They were to bear losses equally. S

would have sole power to operate the building. When lease expired, S entered into a new one w/o M. ii. Holding: S held the lease as a fiduciary for himself & M, joint adventurers. 1. Joint adventurers, like co-partners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workday world for those acting at arms length are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the puntilio of an honor the most sensitive, is then the standard of behavior. iii. To be ok: S would have needed to tell M about the lease (or extend as partners), but also formally dissolved the relationship before resigning. 1. Seems like penalty default rule: Should have bargained for what happened at the end of the lease iv. Dissent: this relationship is understood by the assets it has so the partnership is over at the end of the lease III. Partnership agreements can alter the Fiduciary Duties of partners a. Meehan v. Shaughnessy: Lawyers leave firm & take clients (like Town & Country- grabbing & leaving)- need to disclose i. Facts: partners decide to leave & start their own firm. Other partners ask them if they are leaving and they say no. They had already secured a space, sent letters to clients on old firms letterhead implying (misleading) they had to move to the new firm, and waiting until the last second to give firm the list of clients they planned on contacting. 1. Partnership K: Says you can take cases with you if you pay. ii. Holding: They would be allowed to talked to clients before disassociating with the firm, since this was in the K, but they violated FD by lying, delaying client list, and misleading clients. 1. ABA Rule of contacting clients: need to give a fair chance to compete 2. Breached FD by obtainining an unfair advantage over partners iii. Note: Partners bargained for this allocation (unlike Meinhart) IV. FD of partners to act in good faith: relate to business aspects or property a. Lawlis v. Kightlinger & Gray: Alcoholic partner fired i. Facts: L was a partner who became an alcoholic. Firm told them he had no 2nd chance, but they gave him one & he recovered. They then took his files away & voted to fire him with severance. 1. L sues for: Breach of K (wrongful expulsion- no b/c they just told him intent before the 2/3 vote) + Breach of FD (partners just trying to increase $ by firing him) ii. Holding: They did not breach FD of good faith. His K says 2/3 to fire, there is nothing about intent (no cause provision) & they did not withhold any of his $ or property 1. Contracts alter fiduciary duty: Otherwise it would require a for cause requirement. The basis of the K is that he can be fired in good faith without cause. Partnership Property I. Rule: Partners own a right to profit & loss of the partnership- they do not own their interest in each individual asset of the firm a. Putnam v. Shoaf: Widow sells interest in gin i. Facts: Gin was operated as partnership equally between Cs and Putnams. Putnam husband died and wife decided to get out.. Shoaf bought her interest and assumed all partnership obligations. They found out bookkeeper had been embezzling money since Ps husband died. S sued bookkeeper & won. Putnam wants that money. ii. Holding: Ps intent was to convey her interest to S she sold her interest in the profits & losses from the partnership assets & had no remaining right in the source of profit. 1. No right to settlement money, no specific interest in undiscovered causes of action, only had an interest in the partnership. Partnership owned the COA, so she sold it. 2. Undiscovered cause of action is like undiscovered asset owned by the partnership iii. EXAM QUESTION: Was that person stealing from S? False- he was stealing from the partnership & partners dont own anything but partnership interest

iv. Question: Could P have sold S of the assets of the business? NO- she owns a proportional interest in the revenue & loss generated by the business, so she cannot convey a share of stuff, can only convey a proportional interest in the business b. What partners own: i. Equipment of the partnership owned by partnership and not individual partners ii. Individual partners own interest in profits & losses, not stuff 1. Partner can only transfer his personal interest in profits/losses II. Partnership Capital: Running tally of the value of your partnership interest a. Initial Capital Contribution b. Capital Account: i. A running balance reflecting each partners ownership equity (UPA 1997 401-a) ii. Allocation of profits increases capital account iii. Allocation of losses decreases capital account iv. Taking a draw (distribution) decreases capital account III. Partnership Profits Default rule: Divided evenly by the number of partners (pro-rata) (UPA 1914 18-a; UPA 1997 s 401-b) a. Can contract around it to have different %: Even if you contribute 70%, you need to bargain or will still get pro rata. b. Losses: Follow profit allocation (so pro-rata unless contrary agreement) Partnership: Rights of Partners in Management I. UPA 9(1): every partner is an agent of the partnership for the purpose of its business, and the act of every partner . . . binds the partnership, unless the partner so acting has in fact no authority to act for the partnership in the particular manner, and the person with whom he is dealing has knowledge of the fact that he has no authority a. Every partner has authority to act for the partnership II. UPA 18(b): partnership must indemnify every partner in respect of payments made and personal liabilities reasonably incurred by him in the ordinary & proper conduct of his business III. UPA 18(e): absent an agreement to the contrary, all partners have equal rights in the management and conduct of the business IV. UPA 18(h): any different arising as to ordinary matters connected w/the partnership business may be decided by a majority of the partners; but no act in contravention of any agreement between the partners may be done rightfully w/o the consent of all the partners a. Nabisco Biscuit v. Stroud: Partner buys bread- No majority votes when only 2 people i. F: S & F entered into partnership for a grocery store. S told N that he would not be responsible for any additional breach sold to the store. F later ordered bread. ii. Holding: Because there is an even division of partners, no restriction can be placed on the power to act and Fs actions bind the partnership. Both have actual authority did not matter that S told N. 1. N is suing S b/c partners are personally liable for the debts of the partnership 2. 18(h): needs majority- b/c 1 partner cannot be a majority & change the status quo, they both retained the right as an agent for the partnership to carry on its business for ordinary matters (usual for grocery store to buy bread) iii. 2 conditions for partnership not being bound to partners acts: 1. Partner does not have actual authority 2. Third party knows he does not have actual authority iv. How could S revoke Fs authority? Bargain in partnership K b. Summers v. Dooley: Partner hires a 3rd against the will of the other i. Facts: S & D in a partnership for trash collection. If either could not work, he would pay for a replacement. S hired another; D objected and refused to pay out of partnership funds. ii. Holding: It is unjust to permit recovery of an expense that was incurred individually and not for the benefit of the partnership but for the benefit of 1 partner. iii. D is not liable b/c S was not acting for the partnership 1. A majority is needed to change the status quo & S cannot be a majority- D voiced objection

2. ASK what is the ordinary partnership activity- need majority to change what is ordinary! c. How to reconcile Stroud & Summers? i. ASK: Who is suing? 1. Stroud: payment to a 3rd party; Summers: partner suing each other for contribution for conduct he knew he did not have the authority for ii. It takes a majority to change the status quo iii. QUESTION: If Summers employee sued partnership for payment of salary if he did not know that S did not have hiring authority, who is liable? Under Stroud & 9(1), partnership would have to pay iv. What is ordinary? Grocery store- buy bread; Trash: hiring help? NO V. Day v. Sidley Austin: Firm chairman replaced in merger a. Facts: Day was a senior partner & DC office was going to merge w/2 other offices. Day was chairman of the office before but not after. Office was moved even though Day objected, so he resigned. They said before the merger that no partner would be worse off, & he thought that meant he would still be chairman. i. Breach of K? No- did not bargain for it so no right to be the chair + informed, sophisticated party ii. Fid Duty: Claims 1 partner has advantaged himself at the expense of the firm b. Holding: There is not FD to disclose this type of info re: changes in the internal structure of the firm. There was no financial gain for the Ds. c. Rationale: The firm was run according to the partnership agreement by an Executive Committee & all decisions were made by this committee. FDs are normally concerned w/partners who make secret profits at the expense of the partnership. They did not have to disclose any changes of firm structure where the concealment does not produce a profit for partners or losses for the firm as a whole. i. Partners are owners, but not controllers. (like shareholders) with a few directors having control and constrained by FD (disclosure) d. Partnership agreement CHANGED DEFAULT RULES: too many partners would hurt the businessefficiency mechanism Partnership: Dissolution & Disassociation I. Dissolution: change in partnership relationship which leads to winding up/liquidation (valuation of assets) a. Ways: by act of 1 or more partners; by operation of law; court order II. Under UPA: a. Dissolution (29): Change in partnership relations; eg. The exit of a partner b. Winding up (37): Orderly liquidation & settlement of partnership affairs c. Termination (30): Partnership ceases entirely at the end of winding up III. Under RUPA (not all states have adopted it): a. Disassociation (601): A partner leaves but the partnership continues; eg. Pursuant to an agreement b. Dissolution (801): The onset of liquidating of partnership assets & winding up its affairs IV. The Right to Dissolve a. Owen v. Cohen: Bowling alley partners cant work together i. Facts: P & D entered into partnership agreement to operate bowling alley & P loaned business 7k to be repaid out of profits, but they had disagreements. D was behaving badly and was not reasonably practicable to carry on partnership w/him. ii. Holding: P made out a cause for dissolution. When a partner willfully commits a breach of the partnership agreement and conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him there can be dissolution. iii. P sued for dissolution instead of just dissolving b/c the partnership was for a term- term was until P paid back out of the profits 1. If he did this another way, then D would have gotten more favorable terms by not having to pay back loan

iv. Note: Dissolution does not end the partnership. The partnership continues until winding up has completed (the process of shutting down the business post-dissolution) 1. Problem when they dont specify a term but 1 party argues there is an implied term (usually loan document). a. Here: 7k was a loan, so the implied term is the repayment of the loan V. Partnership At will: similar to employment- can fire the other person at your will a. Dissolution is never a problem- right to dissolve at any time (UPA 31-1-b) b. If term is not specified, at will is default rule c. Page v. Page: Linen supply- partnership at will i. Facts: P & D are partners in linen supply business. For a few yrs it was unprofitable but then news that airforce is coming so they will start making a profit. P wants to terminate the partnership ii. Holding: This is a partnership at will so P has the power to dissolve the partnership by express notice to D. 1. Tries to argue implied term (until profitable) but that would switch the default rule & make all partnerships as terms & all businesses that never become profitable would be permanent a. Term is concrete: lease, repayment of certain amount 2. FD argument: (like Salmon, GE) If P acted in bad faith & tried to use this info for his own personal gain, the dissolution would be wrongful & P would be liable for violation of implied agreement not to exclude D wrongfully from the partnership business opportunity iii. Rule: partnership at will may be dissolved by express will of any partner but as a fiduciary, it must be exercised in good faith 1. A partner may not dissolve a partnership to gain the benefits of the business for himself, unless he fully compensates his co-partner for his share of the prospective business opp 2. Not like Singer case: This is public, not private info (airforce) VI. Partnership At term: Lasts for the performance of the term a. Dissolution: all partners can agree; term comes to an end b. No right to dissolve, but power to; but can have trouble if you use power wrongfully (UPA 31-2) c. Collins v. Lewis: Cafeteria Lease i. Facts: C & L entered into partnership for operating cafeteria. L said he would operate it if C paid the money. Lease was for 30 yrs. There were delays & caf became more expensive than originally thought, so C had to put more money in & he sues to get out (judicial dissolution) ii. Holding: L met his obligations. More $ was due that C refused to pay so L did. C doesnt have the right to dissolve b/c he didnt meet his obligations. 1. Partnership for term: so C had the power, but not the right to dissolve. 2. Test for dissolution: a. There are no reasonable expectations of profit, and b. The other partner is at fault i. L not at fault & expectation for profit. So C could dissolve but it would be actionable breach VII. Consequences of Dissolution a. Prentiss v. Sheffel: i. Facts: 3 guys in at will partnership. 2 guys exclude the 3rd from meetings b/c they did not get along. D sued saying he was frozen out of management (UPA 18e- all partners have rights) BUT b/c it was at-will, excluding him triggered dissolution. There is a judicially supervised dissolution sale & 2 guys buy the assets. ii. Holding: 2 guys are allowed to bid on the assets. No indication that exclusion was done for wrongful purpose of obtaining assets in bad faith but just b/c the partners could not function effectively in the relationship. 1. Reason: D was not injured by their actions. He made more $ than if they did not bid. D also could have bid.

2. Increase value: Have inside info, so more accurate valuation. They have advantage to outsides who would not bid as high b/c they do not know the true value so they discount it. iii. Rule: Such a purchase is proper where D was not wrongfully excluded from the previous partnership & where D has not been injured by the purchase of his former partners. 1. Advantage comes from info, not deception. If anything, them not bidding would have hurt everyone. VIII. Pav-Saver v. Vasso: Inventor loses patent a. Facts: PS is the owner of Pav-Saver TM & patents for the machine (Dale is inventor). Meers is sole owner of Vasso. Dale & Meers formed Pav-Savor Manufacturing C. for manufacture and sale of PavSaver machines. They had an agreement w/terms like during the term of this agreement & patents will be returned to Pav-saver at expiration of agreement. Partnership was having trouble & Dale told Meers he wanted out. Meers physically ousted Dale & became daily manager of business. b. Issue: Should the patents and trademarks been returned to Dale or assigned them a value when determining the value of the partnership assets? c. Holding: The partnership K on it face contemplated a permanent partnership- terminable only upon mutual approval of the parties. PS unilaterally terminated in breach of K. The party not wrongfully terminating was allowed to continue & keep the patents. i. B/c term is permanent the IP would revert back at end of permanent term? K is ambiguous d. UPA 38(2): LOOK AT SLIDE e. Words: WHAT?!??!! i. Expire: partnerships dont expire ii. This is an at will partnership: messed up by writing liquidated damages this way? 1. Fix it: court implied this was an add on punitive damages provision a. So add this provision as the sole remedy in event of dissolution, that assets will be allocated according to this agreement b. Exclusive remedy provision IX. Claims against departing partners: a. Dissolution of partnership does not effect partners individual liability on partnership debts b. Withdrawing partner is still liable for partnership obligations that incurred before departure but no only has control over way business is run Limited Liability you are not personally liable beyond the business I. Limited Partnerships (LPs): hybrid entity that gives benefits of partnership w/limited liability- certain partners give control in exchange for limited liability a. Limited partners are passive investors: do not have control of the business b. General Partner- personally liable for partnership debts & can bind the partnership in dealings w/third parties c. Limited partners share the profits w/o personal liability for business debts- cant participate in management beyond voting in major decisions- may risk losing their LL protection II. Limited Liability Partnerships (LLPs): Qualified limited liability (law firms, acctng firms) a. Liability for only 1 partner who did something wrong to not ruin the others (for specific things like malpractice) b. Limit liability w/r/t partnership liabilities arising from negligence, malpractice, etc.- so limited liability for only certain liabilities c. Partnership-like taxation for everyone: Flow through taxation profits taxed only once III. Limited Liability Company (LLCs): Everyone in the company gets limited liability a. Invested for oil, gas, real estate holdings, etc. b. IRS Reg 7701-1 to -3: four factor test to determine if a LLC should be taxed like a corporation was scrapped in favor of new check-a-box regime that allows all unincorporated businesses to choose between taxation as partnership or corporation (2 tier tax structure: first tax- when business earns the money-profits; second tax: when owner gets paid money- usually dividend) i. BUT: IRC 7704(a): any enterprise w/publicly traded equity faces 2-tier taxation as C-Corps 1. Corporation profits are taxed & when money is given to shareholders it is taxed again

ii. Benefits: federal tax advantages 1. Can pass entity level debt through to members for income tax purposes IV. Formation of LLCs: a. File articles of organization in the designated state office (ULLCA 202(a)) i. Basic contents in ULLCA 203 ii. Pay filing fee & franchise tax b. Other formation tasks: i. Choose & register name: LLC statutes generally require the name of the LLC to include the words limited liability company, LLC or similar phrases (ULLCA 105) ii. Designate office & agent for service of process iii. Draft operating agreement: the basic K governing the affairs of a LLC and stating the various rights and duties of the members 1. Financial Rights: a. Profit & Loss sharing: absent contrary agreement, profits & losses allocated according to members contributions i. Different from pro-rata default rule of partnership b. Withdrawal: member may withdraw & demand payment of his interest upon giving the notice specified in the statute or LLC operating agreement i. Diff from default rule of general partnership- it dissolves partnership c. Interests assignable: unless otherwise provided in LLC agreement i. Like corps: interests can be sold 2. Management Rights: a. Absent contrary agreement, each member has equal rights in the management of the LLC (ULLCA 404a1) i. Most matters decided by majority vote (404a2) ii. Significant matters require unanimous consent (404c); e.g. merger, admission of new member, dissolution b. Manager-managed LLC option is available i. Can be structure as board of directors, CEO or both ii. Must be specified in articles of organization c. Rule: State statutes providing constructive notice to 3rd parties when an LLC has been incorporated do not extend to agency law to get protections of LLC, the other contracting party must be put on notice that you are contracting for a LLC (same with agency) i. Water, Waste & Land Inc. v. Lanham: 1. Facts: Ps contracted w/D to construct a restaurant. Clark, who worked for D, gave Ps his business card but it did not indicate that he worked with an LLC 2. Holding: D is personally liable on the K because P did not know they were negotiating with a LLC Notice is necessary for LLC 3. Rationale: D was acting for a partially disclosed principal & thus remains personally liable on the K the principal is liable as well, but not the members of the LLC (unless they were agents who didnt fully disclose) a. Policy: otherwise would invite fraud b/c the agent of LLC would be allowed to mislead 3rd parties 4. Case similar to: Atlantic salmon (unidentified principal) a. Hold agents liable for Ks for the P: where P is not fully disclosed b. P liable also: A had authority to act for P LLC is judgment proof c. What if they looked online and saw LLC? Would get a 3rd party guarantor OR Lanham wont contract (companies will charge more money) V. Fiduciary Duties of LLCs: Type is dictated by the operating agreement a. Manager-Managed LLCs (not every member is a manager)- like public company i. Duty of care & loyalty ii. Agency conflict between managers & owners iii. Usually, mere members of the LLC have no duties to the LLC or its members by way of being members (& can bring a derivative suit against managers) b. Member-Managed LLCs: like partnership

i. Agency conflicts are among owners- All members have a duty of care & loyalty to the LLC c. Delaware LLC Act 18-1101(c): i. CAN eliminate fiduciary duty ii. CANNOT eliminate good faith & fair dealing d. Rule: Where operating agreement defines & limits scope of Fiduciary Duty, there is no breach analysis by the court i. McConnell v. Hunt Sports Enterprises: NHL team (reminds of Salmon case) 1. Facts: P & D sought to form an LLC to get an NHL franchise but they need an arena before deciding. Hunt is negotiating but keeps rejecting the deals, so award is given to McConnell b/c they would accept it. 2. Holding: Normally there is a FD not to compete, but here the agreement had a clause that members COULD compete w/the LLC. a. May Compete Clause: in any other business venture of any nature, including any venture which may be competitive with the business of the company. i. Poor drafting: will only be 1 team- should say not related to bringing NHL franchise but can compete for food, etc. ii. Fisk Ventures LLC v. Segal: 1. Facts: Segal contributed IP to member-managed LLC. He gets controlling interest in A shares, so he can appoint 2 seats to the board. Johnson controls B shares so he appoints 2 seats. Problem is that convertible debt can be converted to equities. Agreement of management that Class A and B have control over the company but problems how to raise capital and they ran out of cash. Super Majority Provision that needs 75% of board. a. Breached FD: By not doing the 1 thing that would save the company (letting investors investor) so breach DOC and DOL b. BUT look at Section 9.1 (NO FD) c. NO COURT ANALYSIS: clause in K that says no FD except what we put in K iii. Kelly v. Blum: 1. Facts: Subsidiary wholly owned by some of the members. These people negotiate a merger and are interested b/c it will benefit them. Minority claims they are underpaid and they broke Duty by underpaying them a. 7-5 Provision: Managers have to do their jobs b. 7-9 Exculpation Provision: Will not be liable for money damages for breach of FD unless willful break- So tells you FD exists because the K contemplated it c. Implied covenant of Good Faith & Fair Dealing, party must allege: i. A Specific implied K Obligation ii. Breach of that obligation by D iii. Resulting Damage to P iv. Chancery Split: Fish v. Kelly: Statute says you cant contract out of implied covenant of good faith & fair dealing e. Nemec v. Shrader: Corporation i. Facts: Former execs sold their stock at an alleged undervalued price. They get their shares under EE stock retirement plan. Redemption right in the plan so they can buy back the shares at a price reflected. The company then merges w/another company and the hares become worth more. The board redeems retired officers shares. Soon after, the company sells a business division that would have resulted in a great benefit to retired officers if they remained SH. Retired officers sue. 1. Retired officers claim: Board of former company breached corp. stock plans implied covenant of good faith & fair dealing in connection w/the redemption of their shares 2. Holding: You can rely on your contractual rights- they are sophisticated contracting party and show know there might be a change of control, so they bargained for itwhat they want goes beyond implied cov of gf. a. Covenant: limited and extraordinary remedy

b. Its not acting in bad faith to rely on k provisions that limit advantages to another party c. Policy of gf & fd does not extent to post contractual rebalancing of the economic benefits flowing to contracting parties 3. Dissent: You do not violated cov. of GF and FD if you execute a legitimate interest; only arbitrary and unreasonable is violation a. Arbitrary: if no one gains. Here, companies benefit does not change if they redeem or do not redeem retirees shares. So there is a distributive problem, but not arbitrary b. Similar to DOC analysis The Corporate Form I. Lifecycle of a company: LLC or S Corp C Corp Acquisition/Backruptcy a. Some might remain LLCs forever (tax benefits go away when you become corp) II. Different Types: a. Close Corporation: Closely held- organized as a corporation but only a few people own shares of the company; no secondary market; small # of SH actively participating in firm management; looks more like partnerships b. Publicly Held: People can buy shares- owned by many people & shares are liquid; initial offering where selling shares to public for first time; conflicts/FD between directors & SH i. Versus diffusely held Company: No one person or group can exert control (no one has more than 51%); conflicts between owners & boards of directors ii. Controlled: majority owner or very large minority SH with effective control of voting rights; conflict between majority & minority SH III. Basic Attributes of Corporations a. Legal Personality (entities w/legal rights- legal fiction): the corporation is an entity w/separate legal existence from its owners i. Possesses some constitutional rights ii. Separate taxpayer iii. Can sue & be sued (otherwise no one will contract with you) b. Limited Liability (MBCA 6.22(b)): Unless otherwise provided in the articles of incorporation, a shareholder of a corp. is not personally liable for the acts or debts of the corp., except... i. Veil between investors and corp that liability cant go through: stops at the corp ii. Enables investors to be passive and management to be risky without threat of liability iii. Allows diversification of investments- if no LL buying stocks would be too risky c. Free Transferability of Shares (as opposed to interests in partnership) i. Secondary trading markets (NYSE, NASDAW) ii. You want shares to be able to be sold otherwise you wont buy them iii. Diversifying gets rid of risk d. Separations of Ownership & Control: i. DGCL 141(a) Default DE Rule: All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of its board of directors- so default rule that management is appointed by board of directors who are elected by holders of common stock 1. Berle & Means: Produces a condition where the interest of the owner & the ultimate manager may & often do diverge 2. Board of directors liable to SH b/c they elect directors 3. Officers are agents of the corp a. Management: initiate and execution b. Board of directors: monitoring & approval- each have 1 vote i. Broad power: to appoint, compensate, remove officers, delegate authority to subcommittees, declare & pay dividends, amend bylaws, initiate and approve extraordinary corp actions, make business decisions ii. Default: all members of board are elected annually to 1 year terms

ii. Rule of Thumb: 1. Boards ACT 2. Shareholders REACT iii. Shareholders entitled to vote on: 1. Election of Directors (MBCS 8.03-.04) 2. Any amendments to the articles of incorporation & by-laws (MBCS 10.03, 10.20) 3. Fundamental transactions (mergers, MBCA 11.04) 4. Etc., such as approval of independent auditors iv. Corporation as a nexus of contracts????!?!?! 1. Board of Directors: not simply agents, but between trustees & agents; not really employees, no authority except as a board; individual directors do not have corp. authority 2. Managers, employees, creditors, communities, misc. 3. Shareholders: No Ks, residiual interest- all other parties have Ks to protect their rights, but shareholders have long term residual interest, so diff relationship so beneficiarity of FD (no K provision) v. Flexible Capital Structure: The permanent & long term contingent claims on the corps assets & future earnings issues pursuant to formal K instruments called securities 1. Many ways to package such claims: stocks, bonds e. Investor Returns: i. Debt: Bonds- less risk b/c legal right to payment of interest and higher claim than SH 1. Regular repayment of interest (deductible business cost for taxable income) 2. Ultimate repayment of principal ii. Equity: Shares 1. Appreciation (Can sell this) 2. Dividends: no tax is deductible a. DGCL 170a: DE corps can pay dividends out of surplus b. DGCL 154a: Surplus: excess of net assets over capital i. Net assets: the amount by which the total assets exceeds total liabilities 3. Share Buyback: Discretionary a. DGCL 160a1: share repurchased allowed only to the extent that it would not impair the corps capital 4. Residual claimants: equal right to participate in distributions of firms earnings & if liquidation, the share equally in firms assets after prior claims satisfied a. Limited right to participate in corp decision making: elect directors, vote major corp decisions no right to periodic payment; can vote iii. Hierarchy of Claims on the corporations cash flows: 1. Debt is more senior & equity is more junior a. Secured debt b. Unsecured debt (notes) c. Subordinated debt d. Preferred stock: equity security where charter gives special right; payable only when declared by board; might get votes; less risky thank common stock b/c higher place in liquidation e. Common Stock: vote to elect directors, 1 vote per share IV. Incorporation Process a. Draft Articles of Incorporation (Charter): (p. 99 statute book) i. Includes: Name of company (like LLC), address of service of process, purpose (usually to engage in any lawful act or activity for which corps may be organized under this title- DGCL 102a3), capital structure (classes, # of common shares, rights of preferred shareholders if anyauthorized shares, outstanding shared, issued shares), any other misc. provisions ii. Board can amend the charter w/SH approval & vote 1. Shareholders cannot amend iii. Want more detailed charter so that there is more control- bylaws cannot go against charter

b. File w/Secretary of State of Incorporation & Pay Fee c. Typical Structure of Bylaws: Stockholder; board of directors; committees; Officers; Stock; Indemnification; Misc. i. Bylaws are subordinate document: they have to comply w/law & charter (charter does not have to comply w/bylaws)- easier to change 1. More important info goes in charter so shareholders cannot change ii. Bylaws fix the operating rules: establish annual meeting date or how meeting date will be fixed d. Liability for Pre-Incorporation activity of Promoters (?!?!?) i. Under General principles of Agency, the Promoter (as A) owes a FD to the new corp (as P), so if A does not disclose info concerning her financial interest in a sale to the corp, then A must give the profit to P ii. Once the articles are filed, the corp can become a party to the promoters Ks (but ONLY if it adopts the K) iii. If the articles are not filed, or defectively filed, the promoter remains liable on Ks made for the corp e. Where to Incorporate? The laws of the state you incorporate are what governs your business i. Most headquarters: CA, then NY ii. If not where headquartered, most do Delaware: lots of precedent & predictable 1. Majority of provisions are default provisions & allow you to switch the rule in the charter 2. Few mandatory/regulatory rules 3. Race to the bottom (bad): initial managers choose- attract corporations by appealing to managers 4. Race to the Top (good): Shareholders prefer to invest in company w/good corporate law so will earn more proceeds in IPO- good to raise capital Limits of Limited Liability: Piercing the Corporate Veil I. Piercing the Corporate Veil: Mostly issue in closed corps, or single shareholder corp (not publicly traded) a. Meaning: Courts should disregard the corporate form when recognition of it would extend the principle of incorporation beyond its legitimate purposes and would produce injustices or inequitable consequences allows you to reach assets of SH II. Two-Pronged Analysis: Need to meet BOTH? a. Separateness: Separate existence/alter ego/personal control: such a unity of interest and ownership that the separate personalities of the corp & individual (or other corp) no long exist i. Comingling of Funds of Assets- one corp treating the assets of another as its own ii. Disregard for corporate formalities: Failure to maintain adequate corporate records or comply w/corporate formalities; Examples: Failure to: 1. Hold shareholder meetings 2. Hold board meetings 3. Keep minutes of meetings 4. Keep separate books 5. Issue stock 6. Appoint a board 7. Adopt charter or by-laws b. Badness: Circumstances must be that adherence to the fiction of separate corporate entities would sanction a fraud (intent to defraud) OR promote Injustice (element of unfairness) (DE doesnt require 2nd element) i. Misrepresentation ii. Undercapitalization: intentionally undercapitalize the business iii. Examples: undermining common sense legal rules, permitting former partners to skirt rules of partnership, unjust enrichment, parent corp causing subsidiary to incur liabilities and ensuring its inability to pay, scheme to move assets into a liability-free corp while heaping liabilities on an asset-free corp 1. Injustice: more than creditors inability to collect

III. Tort v. Contract Piercing: a. Torts: Care about undercapitalization i. Walkovsky v. Carlton: 1. Facts: D owns Seon Corp. & 9 other corps that own 2 cabs each. Victim is run over by driver, so he sues the driver in tort. D is required to have a minimum insurance policy on each cab & he does. D is shielded because of limited liability. 2. Cannot pierce the corporate veil to get to Carlton- each corp needs to be an alter ego of Carlton a. Lack of Separateness: Sufficient Commingling i. Corporation is clearly working for the benefit of Carlton- he is the sole shareholder of all the corps- shuttles personal funds in and out of corp w/o regard to formality and for immediate convenience b. Badness: Insufficient i. No misrepresentation: no lying here; sneakiness is not enough ii. No Undercapitalization: Liability insurance is anticipating future liability to third parties- just because it is minimum, state can change if they want c. PCV inquiry: whether owner uses control of the corp to further his own rather than the corps business, he will be liable for the cops acts upon respondeat superior b. Ks: Care about Formalities- misrepresentation (lies- need to allocate risk) i. Sea Land v. Pepper Source: 1. Facts: K between PS and SL. PS dissolves & never pays. M owned PS & treats assets of businesses as his own bank accounts, single office and same phone line and expense accounts. SL sues M and his 5 corporations to get the assets of all companies to satisfy judgment. a. Reverse Pierce: Get from M to his other companies, where the assets are, to pay creditors. Corporation would be an alter ego of the D. i. This affects rights of 3rd parties- other businesses have creditors 2. Holding: Shared control/unity of interest test is met. BUT, there is no injustice a. Injustice: Must be something more besides not allowing creditor to collectless than fraud but need compelling public interest i. Creditors inability to collect would always pierce veil IV. Enterprise Liability: In piercing, you try to get to the owner through the sibling corps a. Possible factors for lack of horizontal separateness: i. Common employees ii. Common record keeping iii. Centralized accounting iv. Payment of wages by 1 corp to another corps employees v. Common business name vi. Services rendered by the employees of 1 corp on behalf of another vii. Undocumented transfers between corps viii. Same officers, shareholders, phone number V. Piercing the Corp Veil: Family Corporations a. Policy: Should we think about this differently? i. Griffith thinks OK for parents to have some control ii. Publicly traded corps will not be pierced, but may in corporate subsidiaries 1. Separateness: Number of shares matter- if a lot, then how can there be a unity of interests? b. In re Silicone Breast Implants Products Liability: i. Facts: Bristol Meyers was parent company for MEC, major supplier of breast implants. BM had a lot of control at MEC. MEC injured implant recipients (tortfeaser) and victims want to pierce thru subsidiary corp to get to BM.

ii. Holding: Totality of circumstances need to be evaluated to see if subsid is alter ego of parent corp. (control, not nec. fraud). BM allowed name on implants to increase confidence in the product & to increase sales. 1. Note: Parent-subsidiary relation alone is NEVER sufficient to hold parent responsible. Needs to be so interwoven that hard to see where 1 entity leaves off and the other begins (why it is so rare) 2. Court allows piercing: Kind of K case- focus on misrepresentation (logo on implants & ads)- so victims could not negotiate for protection b/c they were misled iii. Factors: whether subsidiary is a mere instrument of parent corp: 1. P & S have common directors or officers 2. P&S have common business depts. 3. P &D file consolidated financial statements & tax returns 4. P finances S 5. S operates undercapitalized 6. P pays the salaries & expenses of S 7. S receives no business except that given to it by P 8. P uses Ss property as its own 9. Daily operations are not kept separate 10. S does not observe basic corp formalities- books, records, shareholder meetings VI. Costs & Benefits of Limited Liability a. Benefits: Cheaper to shareholder; promotes liquidity; enables diversification; predictability; separation of ownership & control; eliminates costs of monitoring other shareholders; encourages investment (no one would fund if they would be liable for more than their investment) i. Benefits do not really apply to outsiders: or to parent subsidiary group 1. So why limited liability w/in parent-sub group? Industries would vanish if unlimited liability w/in group; would increase prices (try to cross subsidize other companies); would spin off and sell to public where it would be less risky to own b. Costs: leaves losses sometimes; uncompensated 3rd parties i. Creates externalities: solve by having targeted regulation about specific types of risks to make people whole (like cab having insurance) Corporate Accountability Mechanism: Derivative Actions I. Shareholders rights: Vote, Sell, & Sue a. Sue: Right to sue & allege the corporation is not doing what they are supposed to b. Derivatives Suit: Shareholder brings suit on behalf of the corporation ASK who suffered the alleged harm & who would receive the benefit of any recovery? i. Injury suffered by corporation first and plaintiff is secondarily injured by being a shareholder 1. Ex. Someone ripping off company, bad business decision, hiring bad exec, excessive executive compensation 2. Ex. Several members of board engaged in insider trading & want them to pay back company- FOLLOW THE MONEY- who would get paid as a result of suit indicates if deriv. 3. Recovery: If it goes back to corp & shareholders will enjoy indirectly ii. Render directors accountable to shareholders (but lawyers get paid) 1. 2 suits in 1: Against directors for failing to sue on the existing corporate claim & underlying claim of corporation 2. Even if action settles w/o payment but w/management changes, the Ps attorney still recovers a fee from the corp for the benefit conferred 3. If dismissed, Ps attorney gets nothing b/c no benefit iii. Standing: 1. Contemporaneous Ownership: must be a shareholder for the whole duration of the suit (cannot sell shares during the suit) and at the time of the injury (prevents people from buying into the lawsuit) 2. No Obvious Conflict: P has to be fair & adequately represent interests of SH 3. Complaint must specify demand or why demand was futile

c. Direct Suit: When plaintiff (SH) suffers a personal injury i. Direct Claim: no derivative harm to any corporation- someone you hold directly 1. Ex. Rights memorialized by the share (such as voting right, right to elect board) 2. Ex. Shareholder thinks price of merger is too low: FOLLOW THE MONEY- value of transaction would be paid to shareholders ii. Eisenberg v. Flying Tiger 1. Facts: P (shareholder) wants to overturn a reorganization and merger w/FT. He claims the plan was to deprive minority stockholders of a vote but corp says it was for tax benefits. 2. Issue: Direct or derivative suit? a. NY Law: P would need to post $ to sue if it is a derivative suit i. Internal Affairs Doctrine: State of incorporation gives its laws to the company incorporated there b. Right to vote: DIRECT- does not arise as a corporate right, but it is a right of the shareholder. You individually possess it as a right of being a shareholder. i. Core Shareholder Right v. Core Corporate Right ii. Claim that D is interfering w/Ps rights & privileges as STOCKHOLDERS 3. Holding: B/c it is a direct suit, he does not need to post costs. II. Requirement of Demand on Directors: Prior to filing a derivative suit, P must demand the board brings Ps claim (basically sue itself) derivative actions, P must prove good faith effort to obtain redress from corp a. Demand Requirement: allege w/particularity the efforts, if any, made by the P to obtain the action he desires from the directors... or the grounds for not making it. i. So COA must either state demand has been made OR would be futile b. If P makes demand made & rejected: they cannot later assert that the demand should have been excused Board is entitled to presumption of business judgment rule UNLESS P can allege facts w/particularity creating a reasonable doubt that the board is entitled to the benefit of the presumption c. Rule: When a P makes a demand, he waives his right to contest the independence of the board & the demand will apply for all of Ps stated claims (BJR) i. Grimes v. Donald: 1. Facts: P claims board breached their fid duty by abdicating their authority, failure to exercise due care and waste. Donald runs the company & had huge severance agreement & P claims that fear of that would limit the board from firing him. P makes demand on board and they denied it. 2. Issue: Is the sev. Agreement a valid exercise of the directors power? 3. Holdings: a. No abdication claim: if the independent and informed board makes a decision in good faith, it receives protection of BJR unless facts show there is waste or could not be the product of a valid BJ i. Directors must retain control over business & affairs of company but they give all control to Donald- allowed under 141e 1. Does not take away control- just penalty in form of severance b. P made demand, so refusal of board cannot be excused for other legal theories in support of the same claim 4. What could he have done? Make it look like a direct claim d. Demand Futility Test: 3 situations which demand will be excused: (independence) i. Conflict of Interest: majority of the board has a material financial or familial interest ii. A Majority of the board is incapable of acting independently for some other reason- such as domination or control by someone who does have a conflict iii. The BJR wouldnt apply: Underlying transaction is not a valid exercise of business judgmentrare, usually self-interest e. In DE: if you argue demand futility & lose you can still make the demand f. Aronson/Levine Demand Futility Test: Plaintiff must: i. Establish that the directors are interested or dominated- and hence incapable of passing on a demand, OR

ii. Create a reasonable doubt w/particularized facts that the challenged transaction is protected by the business judgment rule (hard to show- illegal transactions) g. Demand Chart On SLIDE i. Derivate Suit: 1. Demand Required: a. Board Sues (good for SH) b. Board dismisses: Shareholder is bound, decision to dismiss protected by BJR i. SH can bring claim of wrongful dismissal but protected by BJR (unless no business judgment) 2. Demand Futile: proceed ii. Demand req. takes suit out of SH hands and into board- right to control SH interests lies w/the board 1. Even if demand is excused as futile, board can dismiss the case- by forming special litigation committee iii. INCENTIVE TO NEVER MAKE DEMAND III. Special Litigation Committee: Board may appoint if no demand is made for derivative suit & demand is excused as futile so case is allowed to proceed Committee who has no conflict in challenged transaction to decide whether suit should go forward & court will decide if they should listen to SLC a. SLC: Independent investigation- looks if there will be detriment to the company and what is in the companys best interest from the companys perspective i. 141 c allows board to delegate authority to commitees b. Zapata Corp. v. Maldonado: DE Rule i. Facts: Deriv. action alleging breach of FD. Demand is excused & 4 yrs into litigation, board created independent committee w/2 new directors as SLC 1. Shareholders have independent, indiv. Right to continue deriv. suit for breaches of FD even if corp does not want to (DE) 2. SLC reasons for dismissal: claim appeared w/o merit; cost of litigation relative to chance of success; waste senior management time; bad publicity, no material injury, impairment of current directors ability to manage, little change of recurrence, lack of benefit to current directors, some challenged practices are good for the company, employee moral, adverse effect on customers ii. If SLC recommends case be dismissed, 2 part test: 1. Process: Corp. has burden (no presumption) of proving independence, good faith, and a reasonable (objective, thorough) investigation a. If SLC fails this step, litigation proceeds 2. Substance: Court will apply its own independent BJ in determining whether the motion to dismiss should be granted c. In re Oracle Corp. Derivative Litigation- SLC MUST BE INDEPENDENT i. Facts: Complaint alleges insider trading (derivative suit- disgorgement of profits) by 4 members of Oracle board. Oracle formed SLC to investigate that suggested the suit be dismissed- 2 professors from Stanford. The SLC didnt disclose their ties to the company or Stanford. 1. SLC reasons for dismissal: company would win- money comes at end of year so even insiders could not have known (hockey stick effect); Cost of litigation; Reputation; Time of execs wasted (further harm company_ ii. Issue: Whether SLC was independent? Needs to show no material factual question regarding its independence iii. Holding: Not independent. Ties w/Standard are so substantial that they cause doubt over whether SLC can make an impartial decision- MTD is denied (Note: usually limited where director is accused of wrongdoing) 1. Demand Excused as Futile: P were asking board to literally sue themselves a. Even though only 4 people, the others on the board let it happen (Caremark claim- lacked good faith in board duties) 2. Traditional Independence Analysis of SLC: Financial & Economic Control

a. NO financial conflict of interest: they gave up extra money and only received money as directors b. Neither were on board at time of wrongdoing 3. New Independence Analysis: Social Nexus- Personal connections that SLC could not evaluate the accused neutrally (not favorably) a. Professors: Stanford employees, research funded by Stanford b. Traders: i. Ellison: Silicon valley titan; prospective Stanford donor, social awkwardness ii. Boskin: Stanford professor; taught SLC member, fellow w/SLC member at think tank iii. Lucas: Stanford alum, large donor to school & think tank iv. Beam v. Stewart: procedurally diff from Oracle 1. Facts: Martha engaged in insider trading of another company. SH brought claim against her for breaching duty to the company by getting negative publicity. Other ppl on board did not trade & make motion to dismiss. a. Ps cite to Oracle: All have interconnected ties b. Narrows Oracle: Personal connections might be a basis to question, but only when there is a personal financial or family tie, or a particularly close or intimate personal or business affinity (that may exceed closeness) 2. Holding: Directors were sufficiently independent in a demand futility case, even though they are close friends and business relationship w/Martha a. Friendship is not enough to rebut the presumption of independence without more Personal connection needs to call independence into reasonable doubt d. Substantial Benefit Rule: Successful P in derivative action can be given attorneys fees against the corp if the corp got substantial benefits from the litigation, even if not financial i. Derivative suits can increase corp value: recover compensation for past harms, governance changes, deter wrongdoing IV. Derivative Suits Today: a. Romano: Shareholder Ps get money the time; Ps lawyers get money 90% of the time b. Brought mainly in federal courts by repeat play law firms (10 firms for 75% of public suit) c. Goal: Make companies run better (not compensate shareholders)- benefits offset the cots i. Ds are public companies ii. Similar allegations as securities suits iii. DATA ON SLIDES V. Corporate Governance Reforms: a. Requiring a majority or more of the directors to meet existing or enhanced independence requirements b. Require the board or committees to meet regularly in executive sessions c. Require appointment or enhanced duties of a lead independent directors d. Require adoption of 1 or more independent directors to the board e. Require adoption of policy allowing the retention of board advisors f. Limit the number of boards which directors can serve g. Require that directors attend a certain amount of board, committee and SH meetings h. Clawback provision in the event of a restatement of the companys financial settlements i. Require adoption of provision allowing major SH to nominate candidates for corps board of directors j. Usually between 2-5 years NOTE: LOOK AT ALL PROBLEMS_ DID NOT DO YET Corporate Purpose I. Corporate Benefit Test: corporations can donate corporate funds for a public cause as long as reasonable serve some sort of corporate benefit, is it not a pet charity-would be a conflict of interest- or in furtherance of a personal rather than corporate ends (would be NO possible benefit) board of corps have broad discretion to promote the corp and public interest

a. Threshold Question: Is there a business/corporate purpose? If yes, then duty of care is insulated by BJR i. Wasteful if no possible rational justification made indiscriminately ii. Might look like bribery if public officials org. b. Common Law: Those who manage a corp. could not donate unless it would benefit the corp c. A.P. Smith v. Barlow: Stockholders questioned donation of company to Princeton University. i. Holding: Donation is valid b/c not pet charity or personal ends. It was made w/a reasonable belief that it would aid the public welfare & advance interest of P as a private corp. and as part of the community it operates (protected by BJR if business purpose) ii. 3 Justifications for donating to Princeton: 1. It is a private institution & the corp. benefit is preservation of capitalism (feared communism then) 2. Employee training & skills 3. Creates GOOD WILL (court does not analyze) iii. Does this actually valuable for corp? 1. Public policy: encourage corps to give to charities if it does not exceed 1% of surplus 2. If corps give too much, people would invest in competitors so market regulates itself d. Philanthropy Correlated w/Performance? i. Yes- philanthropy improves competitive/financial position: growth in donation is positively associated w/future revenue growth for consumer product companies; makes more attractive to potential employees; increased after negative media; tech companies fund education the most ii. No- Detrimental to shareholders: personal interests of board are most important in determining where to donate- social network; larger % of stock CEO has, the less they donate (agency cost); larger boards donate more iii. Critique: Forced redistribution problem- either let shareholders donate their own money or have government tax more II. Corporate Purpose: company is organized for the benefit/profit of stockholders & directors should work towards that end SHAREHOLDER WELFARE MAXIMIZATION Business decision that does not directly increase $ for SH will be allowed with a business justification- protected by BJR a. Rule: A business is organized & carried for benefit of SHs. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or the nondistribution of profits in order to devote them to other purposes. i. Dodge v. Ford Motor 1. Facts: Ford did not want to pay divided, but wanted the profits to be reinvested in the business to build a new plant. Dodge bros. owned 10% of shares and they wanted to sell shares to Ford after new dividend policy. 2. Holding: Duty of directors to pay dividends Ford SHOULD have just said he based the decision on a business judgment b/c new plant would have made more $ for SH & they needed to lower prices to defend against competitors a. Ford said he wanted to employ more people, spread the benefits of the industrial system to the greatest number & that they were making too much profit (so he is looking out for consumers and workers, not shareholders) b. Duty is ALWAYS TO THE SH 3. Problem: Dodge just wanted to compete and enter the car market so they didnt want Ford cars to be lower priced b. Principle Constraint on bad business decisions hostile takeover market c. Penn Statute PACL 102d (SLIDE) III. Business Judgment Rule: a court will not interfere w/a honest business decision absent a showing of fraud, illegality or a conflict of interest a. Core idea of BJR: Courts wont 2nd guess good faith decisions made by independent and disinterested directors b. Decision made w/valid business judgments: (1) made by financially disinterested directors or officers; (2) who have become duly informed before exercising judgment; (3) who exercise judgment in good faith effort to advance corporate interests

c. Shlensky v. Wrigley i. Facts: Derivative suit against managers who will not schedule lights at the field so they can have night games. P says other teams have lights & get more attendance at night games. 1. Wrigley says: lights will hurt the neighborhood and community & people wont come to games anymore ii. Holding: b/c no fraud, illegality or conflict in decision, the court will not interfere with the decision of the directors. 1. As long as there is a rational business purpose, NOT reasonable or the best, the ct wont interfere. Even if it is a wrong decision, as long as they made the decision with a purpose- cts are not business experts Fiduciary Duties: Duty of Care & Loyalty I. Duty of Care: the care of an ordinarily prudent person in the same or similar circumstances a. BJR does not protect fraud, illegal conduct, self dealing, or egregious misconduct i. Loosely constrained- add to SH wealth maximization ii. Accountability decreases when director makes business judgment in good faith b. BJR allocates burden on P to establish lack of care, gross negligence II. Spectrum: a. Accountability of bds of dirs. to the cts --x------*-- --------authority of boards i. X: BJR: boards have a lot more authority to act ii. *: ordinary negligence standard: much more accountability to cts III. Kamin v. AMEX a. Facts: P wants a declaration that a dividend in kind (non cash dividend) is a waste of corp assets. Amex acquired shares of a co. whose value went down. D distributed the shares as a dividend. Ps wanted them instead to sell the shares on the market which they thought would be more profitable. (this is minority SH asking for declaration of dividend to be a waste of corporation assets and make directors not proceed w/distribution or money damages) b. Issue: Did Ps state a claim or should it be dismissed? c. Holding: Not enough that directors made imprudent decision- more than mistaken judgment needs to be shown. BJR so court wont interfere unless fraud, etc. i. Ps wanted: Sell the shares then give a cash dividend. Corp. would get loss in the sale of $26M, so $8M check from IRS from taxes 1. Try to claim self interest (to get around BJR): board bonuses are based on higher profits of company but only 4/10 bd members so not majority ii. AMEX did: Dividend in kind- not an expense and no deductions to profits. It was a nonrecognition event for the corp (tax rule that dividends are not deductible to corp) so shareholders get $4M in DLJ shares 1. Board rationale: avoided a charge against the earnings b/c they didnt want to devalue the price of the comp so the market value will attract more earnings a. Implicit assumption that mkt price of shares follows acting concepts (gross earnings 26 mill) = net earnings (74 mill)- so people would see net earnings whent down i. BUT: market reacts to reality- analysts would follow, not accounting concepts d. BJR: As long as the board makes a business judgment, the court steps back and doesnt ask what an ordinary person would have done like gross negligence i. NOT best business judgment- the can make a mistake, as long as they have a reason (even when quantifiable) ii. So even though they have a negligence argument, they still lose! iii. Hint of self interest here: Inside directors have incentive but only 4/20 e. Why do we have BJR? Even though a lot of professions are hard & have ordinary negligence standard, the boards do not capture the benefit of their actions- where other professions charge more to allocate risk, boards cannot price the risk of liability and we do not want them acting in a risk adverse manner

NOTE: BJR- subsequent SH ratification does not relieve directors from duty to make informed decision unless their approval is based on informed decision IV. Smith v. VanGorkom: FAMOUS for being wrongly decided- Only DOC case that wins a. Facts: Class action brought by shareholders. Company decided to sell itself. VG was the CEO. He met with someone alone to set the price for sale. Board approved merger agreement. There was an option that other companies could make an offer but merger agreement said i. VG: wanted to sell b/c of tax credits and b/c they are not-transferable, the whole company needed to be sold to make use of the credits.- so only way to use the asset was sell the corp 1. No management buyout b/c conflict- board is buyer & seller: BUT could hire special negotiation committee (also VG retiring soon so conflict to sell at high price) ii. Merger agreement: $551. 90 day market check where other bids can come in & could accept superior offer & share confidential info w/prospective buters BUT not allowed to solicit bids + termination fee of 1M shares (Note: reasonable term. Fee is up to 5% and there are risks for buyer- attnys fees, opp. Costs) 2. lockup provision: 1M shares at $38 (termination fee)- courts accept termination fees up to 5% b. Issue: Whether the board reached an informed business judgment in agreeing to sell? c. Holding: The board did NOT make an informed BJ. BJR applied but did not protect board from liability for breach of duty of care (were grossly negligent) i. Problems: Did not know VG role in forcing the sale; approved sale in 2 hours (cash deal- not unusual); didnt read the agreement & none finalized yet, no written summary (Prof says price of $55 is all that mattered- not complicated); lack of outside experts (but then people would always need to hire i-bankers); had to decide by tomorrow (lots of business deals); VG did not disclose how he came to $55 or that he proposed it first (no incentive for VG to mislead b/c he had a lot of money in corp) ii. 141e: directors are protected in relying on good faith reports made by officers 1. Ds presentation here lacked substance iii. Also, Ds signed agreement w/o reading it and it contained provisions diff from what he was authorized to d d. Dissent: these people worked at the comp. for a long time and can make quick decisions.- experts e. Comments: i. Board did not foreclose the deals so hard to justify gross negligence 1. No other bids surfaced: Not b/c of market test provisions (so not board fault) but b/c interest rate on borrowing went up so bidders would need a higher cost of capital Ibankers would have bid if they could ii. Time Pressure 2 hours consideration iii. Leveraged Buyouts: when you use debt to make purchase when your own equity is small 1. Leverage comparison: You buy a building, it costs $1M and you sell a yr later a. Scenario 1: 90% leverage- borrow 900k i. Price increase 20%, your gain is 20%: 200k ii. Price falls 10%, you loose 100%: pay back 900k b. Scenario 2: 0% leverage: price increase 20%, you gain 20%, price falls 10% you lose 10% f. This case suggests that DE Supreme Court is going to be more active in policing corporate conduct: Moves BJR closer to middle of spectrum and gross negligence is a lot less than we thought i. BUT DGCL 102(b)(7) reverses VG decision: allows corps to limit or eliminate the liability of their directors for breaches of the duty of care by adopting an amendment to the charter (needs SH approval) 1. As long as it does not limit liability for breach of loyalty or acts or omissions not in good faith or misconduct, law-breaking, or transactions where directors get an improper personal benefit 2. Most corps have adopted this: so SH can no longer bring suit for DOC claim 3. Must be in charter


V. Rule: A director can be personally liable, even to 3rd parties, if they are grossly negligent B/c she did not use any business decision, there is no BJR a. Francis v. United Jersey Bank- sons steal from mom i. Facts: Mom inherited 48% in company when her husband died. Her sons were taking out lots of $ (that the company was supposed to hold in trust for their clients) and the co became bankrupt. Mom died & this is an action against her estate to recover to creditors. The Mom did not pay attn to any of her duties as a director ii. Holding: An inattentive & uninterested director can be held personally liable for a corps actions. The company held funds in an implied trust that gave rise to a FD to guard the funds w/good faith & her failure to act caused the loss. 1. Directors must: a. Keep informed of the company b. Generally monitor corporate affairs c. Maintain familiarity with the financial status of the corporation by a regular review of financial statements 2. Directors will be immune from personal liability if they discover an illegal course of action by objecting and if that is not followed, by resigning. Sometimes even morereasonable means to prevent conduct 3. Why would SH want a rule like this (ex ante BJR)? Risk aversion- then people wouldnt want to be on boards or would prevent profitable decisions; protects shareholders from each other a. If director makes good decision, they share the gains w/SH so less reason to be risky unless they are sheltered from bad risks iii. Here FD was to SH: but corp insolvent so creditors have right to recovery, even tho no FD VI. Duty of Loyalty: conflicts that permeate a self-dealing transaction rebut the BJ presumption that directors act in good faith need to fully disclose material facts & entire fairness (duty owed to corp & SH) a. BJR allocates burden on P to establishConflict of interest, gross conflict i. If P establishes conflict, burden shifts back to board to establish fairness of transaction 1. Fairness same as arms-length bargain (compare to the market price w/neutral 3rd party) ii. Disclosure Requirement: conflict might be ok if interested directors makes full disclosure of all material facts at time of authorization b. Rule: A director has a FD to support the corps interest over his own conflicting interests and any competing interests render the BJR inapplicable i. Bayer v. Beran: Wife sings in company ads 1. Facts: Dirs. being sued for negligence & waste for radio ad program that cost $100k and presidents wife is the opera singer in the ad. 2. Holding: No breach of FD by directors. The wife singing might have helped her prestige, but the ads served a legitimate & useful corporate purpose & the co received the benefit of it. 3. Rule: BJR yields to rule of undivided loyalty, which includes every situation which a trustee chooses to deal w/another in such close relation that possible advantage to the other person might consciously or unconsciously influence the judgment of the trustee a. Courts will heavily scrutinize these transactions & burden is on the director to prove good faith of transaction + inherent fairness 4. Conflict of interest problems look who is on both sides (here husband is buying publicity but seller through his wife as a beneficiary) + interests that would conflict w/interest as a director a. Solution for boards: Independent committee, vote of disinterested members of board ii. RULE: When a transactions involves a fiduciary duty on both sides, the standard is to show entire fairness to the corporation iii. DGCL 144: gives all conflict of interest/DOL situation rules: a K where 1 person is on both sides of the transaction will not be void or voidable solely for that reason (changes the rule) IF one of these is true:

1. Formation of a special committee or majority votes of independent/disinterested directors in good faith vote to authorize 2. Through a SH vote (but SH do not have to be disinterested like directors) a. Note: Fliegler v. Lawrence says disinterested shareholders is implied b. Power of SH to affirm self-dealing transactions is limited by corp waste doctrine- if completely irrational, still not ok 3. K or transaction is fair when approved 4. LOOK AT ENTIRE DGCL 5. Notes: a. Shifts the burden back & forth b. Directors that vote have to be disinterested in the transaction c. Is strict statutory construction correct? c. Corporate Opportunity Doctrine: a corporate manager cannot usurp corporate opportunities for his own benefit (individual capacity) unless the corp consents (DOL) i. 4 Factor Analysis- What is a Corporate Opportunity? Totality of factors 1. Is the corp financially able to take the opportunity? 2. Is the opportunity in the corps line of business? 3. Does the corp have an interest or expectancy in the opportunity? a. Look to firms practical business expectations- may never be offered it 4. Does an officer/director create a conflict of interest by taking the opp? ii. Rule: A director who wants to seize an opportunity for himself can protect himself by presenting the opportunity to the board, which creates no judicial imposition of liability no formal presentation necessary (but not per se rule if board has no reason to get opp) 1. Broz v. Cellular Info Systems: looks like Meinhard & Singer a. Facts: B is sole stockholder of RFBC. He was a member of board of CIS. RFBC was asked if they want to acquire Mich 2, a license area. B asked CIS if they were interested and they said no. CIS entered into agreements w/Pri to buy CIS. Pri wanted Mich 2 but was outbid by RFBC. b. Issue: By outbidding Pri did B breach his DOL to CIS? c. Holding: No. B was under no duty to consider the uncertain plans of Pri. If he did, then he would need to consider every potential future occurrence. i. This is not a corporate opportunity to CIS: 1. NOT financial able- were going out of business; NOT in line of business- they were selling their licenses at the time ii. BUT b/c B disclosed the opportunity, he did not breach DOL (even if Pri had already closed the deal with CIS) iii. In re Ebay shareholders Litigation: 1. Facts: SH filed derivative suit against ebay board for usurping corporate opportunities. Goldman Sachs bribed the Ds with a good price on IPOs in exchange for Ebays business- which should have been offered to the company instead 2. Issue: Did board breach duty? Did they get the offer from GS b /c of their position and hope that Ebay would give GS their business in future? 3. Holding: The conduct here put the insider Ds in a position of conflict w/their duties to the corp. The directors were not free to accept consideration from GS b/c it was intended as an inducement to maintaining the business relationship w/Ebay iv. When can Fiduciary take an opportunity? 1. Maybe if corp not in financial position to do so or no interest in it 2. Boards good faith decision not to pursue the opportunity 3. 122(17) DE Corp Code: allows waiver in charter of corp opportunity 4. Opportunity is presented to director in his individual, not corp capacity 5. Opportunity is not essential to the corp d. Self Dealing: receiving something from the subsidiary to the exclusion of and detrimental to the minority shareholders

i. Shareholder FD problem where the parent company is a shareholder in its subsidiary: Majority/controlling shareholders have a FD to minority SH to consider their interests fairly whenever the corp enters into a K w/the controller ii. Sinclair Oil Corp. v. Levien: 1. Facts: Sinclair Oil is holding company- made a subsidiary Sinven to explore oil in Venezuala. SO owns 97% of the stock of Sinven. This is a suit brought by 3% SH. SO paid out dividend, usurped Sinvens corp. opps, and did not enforce a breach of K w/Sinclair Intl (another subsidiary of SO) and Sinven. 2. Holding: Excessive dividends were not a breach- BJR. Usurp Corp. Opp- there were no opportunities that came to Sinven so SO could not have usurped them (BJR)--- if parent & sub get same benefit, then BJR applies a. SO DID breach duty by not enforcing the K: self-dealing b/c SO got something from that Sinven that minority SH didnt get He would get 100% benefit or 97% harm, but 3% also harm do not pro rata distribution b. The domination by SO over Sinven requires that any transaction between the parent & sub is subjected to intrinsic fairness standard: burden on SO to prove transaction was fair (arms length) 3. Rule: Intrinsic fairness if self-dealing 4. Rule: BJR if no self-dealing: both parent & sub get same benefit (so only DOC) e. Rule: Unlike a director, a SH is entitled to vote in a manner that is most beneficial to their interests. i. Zahn v. Transamerica Corp: (class a/class b stocks) 1. Facts: P held class A stocks. He claims D forced him to redeem his shares instead of allowing them to participate in the liquidation of the co. where class A stockholders would have received more money on them. Class A stocks were convertible into Class B stocks, but As were also collectible by the corp w/60 days notice. Bs had voting rights. a. Board knew the company had a very valuable asset & intended to liquidate the company by calling A shares and then liquidated so that B shareholders gained on the liquidation 2. Issue: Holders of A stocks didnt know that the value of tobacco had risen and D appropriated the value to itself by redeeming the class A stock- did they breach FD? 3. Holding: The board was interested (Class B shareholders) so Ps can recover- it was a corporate action for the purpose of personal benefit a. Interested Director: One who is also a shareholder, must exercise his duties w/r/t his FD to all shareholders and may not act for his own benefit b. Violation of FD (self dealing to benefit themselves): Information on the inside that outsiders did not know- directors had to disclose the info or abstain from profiting on it 4. Details of the case: & hypos a. A Shares: Callable by corp. w/60 days notice to SH for $60 + accrued dividends; Each A stock was convertible to 1 B stock; A gets 2:1 liquidation preference; Annual dividend $3.20; No voting power b. B Shares: Not callable; annual dividend $1.60; all the voting power c. Assume 100 A shares & 100 Bs. Company has 6k only & liquidates: A would get $40 per share & Bs get $20 i. Do the Bs (who control the firm by controlling the vote) have an incentive to make the firm redeem the As before liquidating? Noredeeming the 100 As for $60 would cost 6k and leave nothing for the Bs d. Assume Company has $30k: If company liquidates- As get $200 per share and Bs get 100 per share i. Bs now have an incentive to redeem As before liquidating: As will get $60 and Bs will get $240. e. Basic principle: you can exercise the rights of the class of shares that they have but non-disclosure is not allowed


Disney Cases: Compensation seems to be BJR b/c DOC & 12b7- usually lose a. Facts: Disney hired Orvitz as president. He was a friend of Eisner, current pres. His employment K gave him a big payout for non-fault termination (he could get more money by being fired than fulfilling his K). The big $ in compensation package came from options (its not real money so cost corp less accounting, gave Orvitz incentive to do well & stay around b/c they vest based on how long he stayed). He was fired after 14 months and got $130 mill b/c his options vested immediately. b. 2000 Suit: Breached DOC: Complaint dismissed for failure to state a claim which relief can be granted. i. Issue: Did board breach FD by extravagant employment k (waste); did they breach FD by agreeing to no-fault provision?; were directors not disinterested & independent? 1. Full board did not consider & approve the agreement: No breach of FD b/c boards can delegate to committees (141e) 2. Comp. Committee process was inadequate: No- this is DOC claim- May not be consistent w/best practices but still adequate (BJR operates) 3. Board erred in hiring in first place ii. Holding: As long as the board made a rational decision, then the BJR applies. If it is irrational, they can show lack of good faith . Any other rule would make courts super directors (irrationality may be waste, or bad faith) 1. Court says: only thing we review is process. Will not look at substance (no substantive due care) As long as not gross negligence, substance does not matter 2. Loyalty argument: Eisner is only 1 person & no facts to show he was such a dominating factor 3. Did not breach DOC for firing w/o cause: concerned about costly litigation by Orvitz (& reputation) iii. Problem: DOC suit for MONEY DAMAGES- precluded by companies w/102b7 provision & will lose no matter what b/c court CANNOT GRANT RELIEF for this claim c. 2003 Suit: Repleaded saying breach of duty of GOOD FAITH (Del. Ch.)- Complaint allowed to proceed i. Duty of Care: BJR, Gross Neg, 102b7 want decisions motivated for SH returns 1. Process: short committee meeting, no written draft, few questions; spent little time (under 1 hour), no expert; no board involved in termination; final draft different from draft reviewed a. DOC: Consider all material info reasonably available in making business decisions b. DE 141 c: allows reliance on experts for BJR ii. Duty of Loyalty: Conflict of interest w/fiduciary interest; entire fairness; cannot further private interests & SH and corps interests are the highest 1. Conflict: Eisner was a close personal friend of Ovitz who carried out negotiations iii. Duty of Good Faith (NEW STANDARD- cause of action): Directors consciously & intentionally disregarded their responsibilities adopting a we dont care about the risk attititude... knowing or deliberate indifference... to the directors duty to act faithfully & with approp. Care is conduct... that may not have been taken honestly and in good faith to advance the best interests of the company. Put differently, all of the alleged facts, if tried, imply that the directors knew that they were making material decisions w/o adequate info & w/o adequate deliberation and that they simply did not care if the decisions causes the corp & its SH to suffer injury or loss 1. Standard is harder for defendants: In real life they would settle b/c no one wants to try it 2. Some Care elements (process) + Loyalty elements (conflict) but neither breached to be actionable on its own iv. Rationale: the facts only need to give a reason to doubt business judgment protection, not a judicial finding that the directors actions are not protected by BJR v. Duty of GF shifts the spectrum on board authority & judicial accountability- now more room for judicial intervention Directors act in bad faith when they at for some purpose other than a genuine attempt to advance corp welfare

1. B/A--------*GF-------J/A d. 2006 Suit: Supreme Court of DE: i. Duty of Care polices the process the board took when making its decisions ii. Duty of Care does NOT police substantive board decisions, those are protected by BJR (no such thing as substantive due care) iii. Duty of Loyalty polices the interests of the board & may be breached when board is acting for some reason other than the corps best interests iv. Duty of Good faith: operates in the background of both DOC & DOL, but it is NOT its own separate duty with an actionable breach (advancing other interests than corps, intent to violate law, fails to act in fact of known duty) 1. Closer to loyalty 2. Intentional dereliction & conscious disregard in the fact of a duty to act v. Holding: Grossly negligent conduct, w/o more, does not & cannot constitute a breach of good faith e. Notes: i. Feds can intervene in corp. governance whenever they want: DE is worries about corps leaving their state if too regulatory (like NJ) they will leave or if too lax, feds will take away corp business 1. DE Courts expand corp. governance when they fear threat of federal preemption 2. There is the threat that if rules are too strict, corps will go away. When times are good, corps are more likely to threaten to leave & less risk of fed preemption 3. DE Judiciary is stuck between threat of corporate migration & threat of federal preemption ii. Disney shows how corp law works, moves, expands, contracts iii. Good Faith remains: Narrowed from 2003 decision- will likely shift again iv. Law that comes out of Disney: Stone v. Ritter? VIII. Oversight & Compliance: Every derivative suit is a CAREMARK case: intentional dereliction/conscious disregard in the fact of a duty to act a. Best argument for demand futility the whole board did something wrong (but not most cases) i. Get out of demand failure to monitor/compliance/oversight b. Caremark (loyalty)(396): a directors obligation includes a duty to attempt in good faith to assure that a corporate info & reporting system, which the boar concludes is adequate, exists, and failure to do so may render a director liable for losses caused by non compliance w/appropriate legal standards i. 2 Conditions: (1) Directors utterly failed to implement any reporting or info system or controls; (2) having implemented such controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention c. Stone v. Ritter (DE Supreme Ct. 2006) i. Facts: employees in bank were operating ponzi scheme that could have easily been uncovered. Directors failed to monitor. Company has 102b7 provision (if duty of care, it would COMPEL dismissal but this is failure to monitor ii. Where directors fail to act in the fact of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith 1. Back to dichotomy: care & loyalty a. Loyalty is slightly different: Conflict of interest + interpreted broadly enough to include intentional disregard iii. Holding: No director liability bad outcome is not evidence of bad faith: Directors are no responsible for ensuring the legality of every act by employees, even if it had been discovered if there hadnt been a failure of the corp compliance program IX. 2008 Financial Crisis: collapse of US housing market values of homes were less than the value of the mortgages so people defaulted b/c they could not afford high interest rates a. Interest rates on mortgages: Variable- after a few yrs they reset at a higher rate b. Diversification: If you own a lot of mortgages, the risk is offset c. Securitization: Collection of cash flow rights in a pool & sold off as securities to other investors

d. e.


g. h.

i. Mortgages are underlying asset in: Mortgage backed securities & Collateralized Debt Obligations Financial institutions hold MBOs and CDOs ii. Homeowners default on mortgages massive losses for financial institutions b/c they thought house prices would keep rising Incentive problem: Loan person does not collect payments, only commission; less risky investments pay less interest rates In re Citigroup: Seeking to recover from the company its losses arising from exposure to the subprime lending market DISMISSED i. Ps claim: D breached FD by failing to properly monitor & manage risks the company faced from problems in subprime lending market & for failing to properly disclose citis exposure to the subprime assets ii. Caremark Claim: Board was SO recklessly & knowingly indifferent that they did not install sufficient compliance procedures to make sure wrongdoing would not occur usually Red Flags to give Ds notice of the problem (LOOK SLIDE) 1. Red Flags not illegal conduct here- overinvestment in super risky assets is a bad business decision but not illegal 2. Dismissed b/c did not plead w/sufficient particularity: merely newspaper clipping (narrow construction by paticular facts) nothing to state of mind of directors iii. Holding: NOT that a business risk cant give rise to CM Claim In re Goldman Sachs: SHs claim directors breached FD by approving compensation structure (pay for performance- links total compensation of employees to net revenue so if company has losses, it only falls to SH, not employees) DISMISSED i. Claim: There is motive for GS employees to do illegal stuff b/c they are compensated for generating risk- they made too risky short term returns and saddled risk on SH ii. Dismissed: Red flag here was Abacus transaction (sold something to client and company bet against it) against, BAD transaction but NOT ILLEGAL iii. Bad business decisions are not red flags Citi & Goldman: Illustrate dichotomy between legal compliance & business risk: it is NOT impossible to bring caremark claim for business risk BUT it is hard to get that super strong standard so needs to be very particularized What to tell clients: Have adequate compliance measures for business risks as well & that business risk is separate from legal risk

Accountability Under the Securities Laws: Rule 10b-5 I. Purpose of securities law: fix the stock market after Depression (state law seemed to be inadequate) a. Purpose of rules: full disclosure, prevention of fraud II. 2 most important securities laws: a. Securities Act of 1933 (Securities Act/33 Act): regulates the offering & sale of new securities (IPOs) b. Securities Exchange Act of 1934 (Exchange Act/34 Act): Regulates secondary market activity i. Created SEC: independent regulatory agency: job is to enforce the securities laws and to promulgate rules that are consistent w/the 33 & 34 acts III. 2 Approaches to Disclosures: Reporting Requirements a. Securities Act: Transactional disclosure (registration statement filed w/SEC & prospectus distributed to investors) required in connection w/any public sale of securities unless an exemption applies b. Exchange Act: Periodic disclosure: recording obligations for companies that are already public (already registered)- 10k annual, 10Q quarterly, 8k episodic (significant transaction) IV. Securities Exchange Act 10b: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement, any manipulative or deceptive device or contrivance in contravention of such rules & regulations as the commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. a. Note: not self executing (as the commission prescribes)

V. Securities Exchange Act Rule 10b-5: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, a. To employ any device, scheme or artifice to defraud, b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person d. In connection with the purchase or sale of any security i. NOTE: if NO shares are transaction, then no cause of action (only buyers & sellers have standing ii. Neither 10b or 10b-5 say anything about private rights of action, BUT supreme court has allowed them under 10b-f for purchaser or seller of securities (not just holders) iii. In $$$, these are more important than derivative suits- not high value but a few with super high settlements: brought as class actions among class of investors who all suffer essentially the same harm (buy & sell during the period of misinformation) VI. Traditional 10b5 Analysis (looks at stock price reaction to news) a. Scienter (state of mind): P must show that the D acted with an intent to deceive, manipulate, or defraud i. Negligence/making misstatement by accident is not enough, but maybe recklessness (PSLRArecklessness must approach intentional fraud- must have strong state of mind facts) b. Causation: P must show that the misstatement caused the harm- caused you to enter the transaction (then D rebuts that the misstatement did not contribute to the loss) if you show stock price effected, thats good i. Eg. If corp issues overly optimistic press release, P must show it raised the price of security, but D would try to rebut claim w/evidence that it did not contribute to the Ps loss ii. Omissions: you wouldnt have entered the transaction if the info was disclosed c. Materiality: Substantial likelihood that the disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of info made available i. How to apply when faced w/uncertain and contingent facts? Probability & magnitude so not all deception is actionable, only material. In general, if it affects the stock price, it is material ii. No duty to disclose, but material if omissions to disclose material fact d. Reliance (traditional element of fraud): Purchaser/seller rely on the statement in entering into the transaction Presumption of reliance (investors rely on the integrity of the market generally & the market reacts to information) public only i. Fraud on the Market Theory: any public statement then youre deemed to have relied on the misstatement- b/c it affected the price & motivation to buy/sell is based ion price, so if that price incorporates the fraudulent info then relying on the price, you relied on fraud. (efficient capital market hypothesis- Easterbrook) 1. P doesnt have to prove anything- it is assumed- but D can rebut (by saying pros are not deceived, truth entered market despite misstatements, specific Ps would have sold anyway) 2. Criticism of FOTMT- Irrationality in markets: in general, irrational buyers or sellers wont effect the efficient market theory b/c theyll balance either other out. The only problem is w/items that are hard to short (real estate, tech bubble). So long as there is liquidity, the market gives useful info a. What about when irrational traders act together? Arbitrageurs can correct it 3. Requires: material public misrep, efficient market, efficient capital markets hypothesis a. Strong: all info public & private is compounded b. Weak: all historical info in the price 4. Semi-strong: similar to FOTMT- Professionals adjust their reservation values to new info & will not buy or sell except at prices reflecting new info 5. Important for class certification purposes ii. LOOK AT SLIDES

iii. ECMH implications? e. Basic Inc. v. Levinson: if this was decided differently, 10b-5 class action wouldnt exist i. Facts: Basic is publicly traded co. B began merger negotiations w/Com in 76. During 77 and 78 B made 3 public statements denying it was involved in merger negotiations. Ps who sold stock after first denial sued saying they would have held on to the stock or made money on the sale if the info was public. ii. Holding: Mergers can be important in company, so whether the merger discussions are material depends on the facts- material to reasonable investor- MISTATEMENT 1. Disclosure (not paternalistic withholding) of accurate info is what Congress chose 2. Ds claim: didnt want to mess up deal so acting in the best interests of SH BUT 10b-5 doesnt care if the lie is w/good intentions or not (they SHOULD have just said no comment) 3. Damages: difference between price when SH sold jump in price when they told the truth 4. Note: Corp does not have to be a party to buy/sell stocks, transaction is by SH iii. 10b-5 analysis: 1. Scienter: Intentional to deceive, protecting the transaction still had the intent- simply need intent to mislead 2. Causation: misstatement held the stock price down 3. Materiality: it affected the stock price a. Omitted fact: balance probability it will occur with magnitude if it does 4. Reliance: presumption iv. Advice to all: IF you say anything, if should be accurate 1. If you had made an inaccurate statement (or a live statement that has become inaccurate) you have a duty to correct it 2. BUT generally there is no affirmative duty to disclose preliminary merger negotiations f. Should ordinary investors be able to sue in 10b-5 private right of action? YES i. Deterrents: create private attorneys general- institutional investors wont care ii. To compensate them/make them whole g. Fraud on the market theory is not extended to situations where non-public/Private false info is relayed to a small number of investors i. West v. Prudential 1. Facts: Hofman, a stockbroker, made statements to 11 customers that a company was certain to be acquired in the near future (it was a lie). Ps claim that Hs false story artificially raised the market price & Ps paid for the stock when it was artificially high. 2. Issue: Whether non-public misrepresentation can be a basis for a claim under FOTMT- NO 3. Holding: No class certification here. This lie didnt affect the market. Maybe initially, but after 8 months and no acquisition shows it was a lie. There was no significant effect on volume of trading, a. Public info incorporated into the price, but non-public info is not. i. But: Private info can get into the price by volume of the trades OR by the identify of the person placing the trade (serves as a proxy for inside info) so if CEO starts selling stock, might indicate something to the market & people will follow b. Misrepresentation does not have to be made by the company- as long as the person has standing (bought/sold) 4. Note: securities are perfectly fungible- people buy b/c it alters their risk & return, so they have flat demand h. 10b-5 is about fraudulent misreps, not state law (breach of fid. Duty) i. Santa Fe v. Green 1. Facts: SF owned 90% of Kirby stock & wanted to get the rest. DE law permits DE corp to merge w/approval of board and to make payment in case for the shares of the

minority as long as notice is giving to the minority SH so they can contest the value. SH received $150 for shares. They argue the transaction itself was a problem- that it is a device, scheme or artifice to defraud under 10b-5- that a squeeze out merger forces them to take less than the securities are worth is a fraudulent device. 2. Issue: whether low valuation in cash-exchange offer is fraud? NO 3. Holding: The behavior wasnt manipulative or deceptive- there was no failure to disclose or material misrep. The SH could accept or reject and seek appraisal in DE court. a. Courts refuse to federalize corporate law under 10b absent congressional intent- area left to state law i. DE rule was decided to prevent holdout problem b. Internal affairs doctrine: Corporate governance is regulated by state law; disclosure & secondary market is regulated by fed law. If the court ruled, it would preempt DE corp. governance. 4. DGCL 253: allows parent that holds 90% of shares in a subsidiary to value the minority interest, merge w/the subsidiary and pay off minority SH w/o SH vote 5. Sarbanes Oxley Act- Shifts the balance: federalized certain aspects of corp law. a. Proscribed Transactions: some transactions proscribes that would otherwise be legal i. 304: claw back of CEO and CFO compensation when financials restated due to misconduct ii. 306: No executive trades when ees cant trade iii. 404: no loans to company execs b. Board procedures: i. 404: internal control reports 1. to make sure accounting in firm is ok (controversial)- & audits- additional expense & outside auditor involvement 2. previous internal control was state law & DOC/DOL ii. 406: code of ethics for senior financial officers iii. 407: financial expertise of audit committee members c. Board Structure: i. 301: audit committee required w/specific composition VII. Overview: Shareholder Litigation- Basic concern that comp. managers have misused their positions to the disadvantage of their SH a. State law derivative suits i. Breach of FD resulting in harm to corp. b. State law direct suits i. Breach of FD resulting in harm to SH individually (especially in acquisitions) c. Securities Lawsuits (10b) i. Framed around misrepresentations or inadequacies in corp. disclosure ii. Basic concern that comp. managers have misused their positions to the disadvantage of their SH d. Erickson- overlap between deriv suits & 10b-5 cases e. Directors protection: BJR, exculpation, 102b-7 (duty of care), insurance & indemnification f. Pocket shifting Critique of 10b5 fraud on market action: goes from 1 investor to another i. When co loses suit: SH are paying out of SH class, so basically paying themselves. 1. There is a tax on this transfer- the money paid to lawyers g. Affirmative Defenses: i. Proof that person had pre-made plan before getting info ii. Proof that person was unaware of inside info iii. They entered into the transaction before getting inside info Indemnification & Insurance I. Insurance: 3rd party insurer pays for liabilities- only for claims during period of time, even if action was before

a. Indemnification: company itself pays for liabilities II. DE-GCL 145: Directors & Officers Indemnification & Insurance a. A. Allows indemnification of expenses, judgments & settlements for actions except derivative suits as long as D acted in good faith b. B. Allows indemnification of expenses incurred when derivatively sued (not settlement or judgment) as long as D acted in good faith i. If deriv suit is successful, the bad guy pays the money back in to the company so if indemnification is allowed then no fain for company ii. But to avoid risk aversion can still indemnify for expenses c. Must indemnify directors/officers if successful on the merits or otherwise in defense d. E. Expenses...incurred by an officer or directors in defending any civil, criminal, administrative, or investigative action, suit or proceeding may be paid by the corp in advance of the final disposition of such action...upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the corp as authorized by this section e. F. the indemnification...granted pursuant to the other subsections of this section shall not be deemed exclusive of any rights to which those seeking indemnification... may be entitled f. G. Allows for the purchase of insurance for conduct that the corp cannot indemnify (bad faith acts & derivative suits) III. DGCL 145- If it is a derivative suit, you may indemnify for expenses but not judgments/settlements (so cost of defending) a. B/c the corp is the P in a derivative suit- the director has to pay back the co for $ they stole but then the corp would be paying itself- circular wealth transfer. So no indemnification in deriv suits IV. Directors & Officers Liability Insurance: every public co has this. It makes them whole/paid if they are the Ds in some lawsuit as a result of their being directors a. 3 aspects of insurance policies: i. A- Insurer pays manager when corp. cannot legally indemnify. It only pays to the people when the corp cannot legally indemnify them (deriv. suit). A pays deriv suits- also when corp is insolvent & cant pay b/c of bankruptcy laws 1. Managers insist on this ii. B- payment from insurer to the corp for indemnifying managers 1. Corporate Reimbursement for indemnification iii. C- pays losses for which the corp itself is directly liable (securities claims) 1. Arguments is that the insurance B & C gives managers something at the expense of SHs b/c SHs could insure themselves for free by diversifying their stock. And the problem is that insurance takes a bite out of corp governance b/c the party you are trying to deter doesnt have to pay any money b. Notes: LOOK AT SLIDES i. Premium: actuarial probability of loss over the lifetime of the corp ii. Deterrence is main reason for SH litigation iii. Problem: insurance subverts deterrence and makes SH litigation look like waste 1. Side A: very few payments under A, deriv suits almost never settle for money- might work only in case of insolvency (about the people) 2. Side C: only securities claims will name company as a D a. Also 10b5 3. Side B: Reimbursing iv. Insurance co can charge higher premium to riskier companies which will be an inducement to company to reduce their risk to reduce the premium v. If there is actual wrongdoing, insurance co can get out of claim vi. Policy Exclusions: 1. Conduct is sufficiently self serving or egregious 2. Conduct that insurance is available under other policies 3. Reckless, willful, criminal conduct c. Reintroduce Deterrence: i. Through pricing

ii. iii.



1. Insurers try to price to risk a. Financial factors: industry, maturity (how long as been a public co); market capitalization; volality of stock b. Governance: Not (primarily) charter provisions; culture & character 2. But does pricing deter? Difference between good & bad cos is $100ks, not enough to change corp policy Through monitoring: the co comes in Through selective payment of claims: Selective settlement 1. D controls the defense (unlike other insurance where insurer has control over defense) but insurer has veto power over settlement 2. BUT: a. Effect of settlement demand w/in limits i. Risk of bad faith failure to settle claim, making insurer liable beyond limits ii. P & D counsel collusion b. Absence of guidance: i. No public records of settlements c. Coverage defenses: i. Exclusions (esp. fraud): Policy language- actual fraud determined by adjudication 1. Strategic pleading: recklessness ii. Rescission (for fraud in the application): weakness of rescission threat given market constraint 1. Insurers basically never rescind b/c then they are unable to sell future policies iii. But tradeoffs to make insured pay into within-limits settlementscashing in coverage defenses (SLIDES) Disclosure Solution: 1. Mandatory disclosure of: a. Premium, limits, structure & other policy details b. Amount & structure of coverage and structure of settlements i. Who funds settlement & defense costs ii. In what proportion Takeaway: Real function of SH litigation is deterrence and does this actually occur in a regime that allows insurance?--> makes SH litigation look like waste 1. DO transfers the risk to insurer

Insider Trading I. Common Law (pre-securities law) of insider trading (before SEC took away state legislation) a. No duty rule: liability for actual fraud (misrep or fraudulent concealment)- Acts that prevented the P from investigating further b. Duty to disclose rule: Got info as insiders, gave rise to a duty to disclose to SH before trading with them c. Special Circumstances rule: Generally no duty to disclose unless special circumstances, especially (1) concealment of identity by the D and (2) failure to disclose significant facts having a dramatic impact on the stock price d. Common law insider trading: Goodwin v. Agassiz: i. Facts: D (directors of company) bought stocks which P had previously owned (but done through brokers so neither knew identities). D knew there was exploration going on the property & that a geologist there would be deposits but kept info to themselves. ii. Holding: There are no facts that place an obligation on the Ds to disclose what they knew. P acted in his own judgment to sell the stock. 1. If Ds disclosed the theory, they might be sued by those who acted on it thinking it was correct.

2. This has been superseded but important that b/c it was an anonymous trade on the open market, so directors were not liable- no face to face lying II. 10b-5 Insider Trading: Anyone trading for his own account in the securities of a corporation has access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone may not take advantage of such information knowing it is unavailable to those with whom he is dealing (investing public a. Directly or indirectly: Outsiders of corporation who come in possession of info some other way (Tippees- person an insider tells); Directly- director, officer, agent, major SH i. If a would-be trader has material inside info, then he must either (1) disclose it to the investing public or (2) abstain from trading or recommending the securities while such inside info remains disclosed ii. Core of 10b-5 is equal access: level the playing field- insiders cannot have an advantage 1. Based on inherent fairness of exploiting an informational advantage 2. Pros: reaches all conduct that may be inside trading, victims are all uninformed traders 3. Cons: no pre-existing disclosure duty, investors get information other ways b. SEC v. Texas Gulf Sulfur: i. Facts: D was drilling & found area of high mineral content. To preserve the opportunity for the co to buy the land w/o driving up prices, employees had to keep the results secret. Rumors started spreading. On 4/12, company issues a statement that they did not find anything. Ds started making stock purchases. 4/16, made an official announcement of discovery & stock prices went up. Corp. is being sued for press release (standard 10b-5 violation) & employees sued for insider trading. ii. Issue: was info here material that possessors should have disclosed or refrained from acting on it? Was 4/12 statement misleading? iii. Holding: All stock transactions made by people who know drilling results violated 10b-5. 1. In connection w/purchase or sale of any security: intent that the device be of a sort that would cause reasonable investors to rely on and cause them to buy/sell securities. (remanded to see if they would have been misled by the statement) a. Affirmative misrepresentation b. Materiality: easy for IT- the trade itself (unless part of phased, pre-planned process) makes it material c. Reliance- ROTMT- price reacts d. Hardest element: scienter- intentionally misled- INSIDER TRADING helps show scienter b/c they traded & knew it was false 2. Effective dissemination: you have to wait for info to be disseminated before you can trade so it is in the public and can be incorporated into the price c. Chiarella v. US (OVERRULED) i. Issue: whether an employee at a printer, who figured out what the target corp. was and bought shares of the target, violated 10b-5 ii. Holding: Not liable b/c 10b-5 duty to abstain from trading or disclose is based upon a fiduciary relationship between the SH of the company whose shares are traded & the insiders, not just the possession of inside info. D was not an insider of the company. 1. Insider trading has to do w/unfairness: they should have had a K w/printer d. Rule: A tippee assumes a FD to the SH of a company not to trade on material nonpublic info ONLY when the insider tipper has breached his FD to SHs by disclosing the info to the tippee & the tippee knows or should know that there has been a breach FOCUS on HOW THEY GET THE INFO i. Dirks v. SEC 1. Facts: Dirks, an investment analyst, received material nonpublic info from insiders of a company, that he had no connection with, that the co. was involved in fraud & their stocks were overvalued. He disclosed the info to some investors who relied on it by selling shares of the corp. He tried to investigate and told people about it to try to make the info public. a. Tipper/whistleblower: Secrist; Tippee: Dirks 2. Holding: Dirks did not violate 10b-5. There was no expectation by his source that he would keep the info private. Unless the insiders breached their duty to SH in

disclosing the nonpublic info to Dirks, he breached no duty when he passed it on. (he also helped fraud become uncovered) a. How to determine when breach of insiders FD? i. Look at purpose of disclosure ii. Whether the insider personally will benefit directly or indirectly from disclosure iii. If no personal gain, then no breach of duty 1. Tipper didnt breach FD b/c no personal benefit 3. Where temporary fiduciaries (lawyer, accountant) are given corp. info for corporate purposes (like Chiarella) they are expected to keep the nonpublic info confidential ii. Two elements to establish 10b5 violation: 1. Existence of relationship giving access to inside info intended to be available only for a corp purpose 2. Unfairness of allowing corp insider to take advantage of that info by trading w/o disclosing e. Misappropriation Theory: a person commits fraud when he misappropriates confidential info for securities trading purposes in breach of a duty owed to the source of the info i. Different from Dirks- changes where the FD is locates a duty and a fraud ii. Does not provide civil recovery other than entity who owns the information rights f. No private remedy under 10b-5 unless: P is of class for whose special benefit statute was enacted; indication of legislative intent to provide remedy; no remedy from state law g. US v. OHagan i. Facts: Lawyer representing a co that wanted to buy Pillsbury bought stock in Pillbury. ii. Holding: Layer is guilty of misapprop. Violating 10b & 10b5. b/c he deceived those who trusted him w/access to confidential info 1. SEC did not exceed its rulemaking authority by adopting 14e-3a (proscribes trading on undisclosed info in the tender offer setting even if the absence of a duty to disclose) supposed to prevent fraud trading on material info 2. Lawyer breached his duty owed to the source of info- liability is premised on a fiduciary-turned-traders deception of those who entrusted him with access to the info III. SEC Enforcement powers: Disgorgement of profits, monetary penalties, injunction, ban on future service as officer, criminal prosecution (up to 25 yrs in jail, fines- millions) a. High penalty: detection rate is low, benefit of activity is high, so need to deter b. Question: does insider trading even harm anyone? i. It makes the market go up to the event price more quickly- distributional question that insiders will get more ii. You will systematically lose against insiders c. Example: i. Waksal: IMclode Insider- had knowledge of FDA approval, so he sold shares & tipped to others will get in trouble ii. Bacanovich: broker- handled Waksal and tippee sales: source of info is his job & he called his best clients iii. Martha Stewart: B called her and she sold her shares- should she know or should have known that B breached his duty? Probably b/c she was a stock broker before 1. If it was only advice, not a real tip, It might be ok Short Swing Profits I. Rule 16b of Exchange Act of 1934: Profits from purchase & sale of security w/in 6 months a. For the purpose of preventing the unfair use of info which may have been obtained by such beneficial owner, director or officer by reason of his relationship to the issuer, any profit realized by him from any purchase & sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security)... shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner... This subsection shall now be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase & sale, or the sale &

purchase, of the security.... involved, or any transaction or transactions which the commission by rules & regulations may exempt as not comprehended w/in the purpose of this subsection b. Requires specified insiders to report their trading in their companys securities, and authorizes the corp to recover from these insiders any profits made on stock transactions in a narrow 6 month period (short swing trading profits) c. Different from 10b-5: i. There must be a profit ii. Does not include debt securities unless it is convertible into a class of equity security iii. Intent does not matter: bright-line insider trading rule iv. Applies to insiders (officers & directors) + beneficial owners (owners of 10% of class of equity securities- owner or any class of equity) All that matters is identity 1. If 10% owner of class A stock and traded class B still, still covered 2. If someone is an insider then quits still ok- just have to be an insider once w/in 6 month period 3. Beneficial owner: has to be both when you purchase AND when you sell 4. Reason for 10%: they have access to high level people & get info- so we can piggy back on their buys/sells to guess how corp is doing v. Match any purchase w/any sale, regardless of order, during the 6 month period where the sale price was higher than purchase price (highest sale price to lowest buy price to determine overall liability, even if net loss) II. Rule: SH must be a beneficial owner immediately before both transactions (so BO status must exist at both ends of the matching transaction) a. Reliance Electric Co. v. Emerson Electric Co. i. Facts: E acquired 13.2% of cos stock. Then he disposed of enough shares to bring it down to 9.96% (so that he can dispose of the rest of them w/o 16b liability) ii. Holding: The profits derived from the 2nd sale are not recoverable from the corp even though they are part of the plan b/c he had less than 10% during 2nd sale.- still liable for profits from first sale 1. If the plan was to sell after 6 months, then it wouldnt be recoverable 2. Purely FORMAL RULE- form over substance- easy to administrate b. Beneficial Owner: needs to be 10% SH immediately before the purchase the securities at issue (so not the transaction that crosses 10% threshold) i. Foremost-McKesson Inc. v. Provident Securities Co. 1. Facts: Ds got the securities in a bankruptcy- more than 10% and they want to sell the shares- but they might be liable under 16b to disgorge the profits 2. Issue: Whether a person purchases securities that put his holdings above 10% is a BO at the time of the purchase so that he must account for profits realized on a sale w/in 6 months 3. Holding: In a purchase-sale sequence, a beneficial owner must account for profits only if he was a BO before the purchase a. Going into the transaction which will make you a BO- does not count as matchable transaction for 16b. The transaction that takes you over 10% doesnt count, after that it does. You ask BO question going into the relevant transaction c. 16b Technicalities: i. Issuers: companies registered under 1934 Act 1. Co w/publicly traded shares or that has $10 mill & 500+ SH ii. Officers: An issuers president, principal financial officer, principal accounting officer, any VP of the issuer in charge of a principal business unity division or function, other officer who performs a policy making function iii. Equity Securities: also convertible debt iv. Multiple classes: courts consider classes separately to determine if 10% threshold has been met but once a SH meets 10% req. for any 1 class of stock, he is liable for short swing profits that he makes on all classes of stock, regardless of whether he owns 10% of the class generating the short swing profits

v. Matching: courts match transaction to generate the most profits- not accounting principles, but lowest prices purchase w/highest priced sales d. 16b problems p 507: i. 1. CEO bought 20% on Jan 1 for $10/share- 200k shares- CEO- any # of shares liable for profit b/c he is an officer so 10% is irrelevant 1. Sells 200k shares May 1 for $50: liable for 40x200k= 8M 2. Sells 110k May 1 for $50, 90k May 2 for $50 still liable b/c CEO (8M) 3. Sells 110k May 1 for 50, resigns and sells remainder liable for 8M- officers only need to be officer during 1 transaction 4. Note: IF non-insider, then does not become BO until after 1st transaction so no liability ii. 2. Investor w/200k shares. 1. Sells all 200k on Jan. 1 for $50 (matchable) , May 1 buys 50k for $10 (only 5% so not matchable), May 2 buys 110k for $10 (going into transaction 5% owner so not matchable) a. She is not BO when enter into May 1 transaction so no liability 2. Jan 1: sells 200k for $50 (matchable), May 1: buys 110k for $10 (not matchable b/c not BO before), May 2: buys 50k for $10 (matchable b/c 11% holder before) a. Liability for May 2 transaction b/c 11% BO- owes company b. So 50k x 50 (10 x 50k) 3. Jan 1: Sells 110k for 50 (Matchable- BO at time of sale); Jan 2: Sells 90k at $50 (Not matchable- not BO); May 1: buys 300k for $10 (not matchable b/c not BO) a. So no liability iii. 3. CEO: March 1: buys 100k at $10, April 1: 700k at $90, May 1: Sell all (800k) for $30 1. March 1: Spent 1M; April 1: Spent 63 mill; May 1: Made 24 M= lost 40M 2. No profits BUT 16b liability still March 1 transaction matched with May 1 a. So 100k x 20= 2M iv. 4. Investor owns 5k convertible debts (Debt security)- face value 1k each. She paid 1k each, so paid total 5M. Debts convertible to 100 shares common stock. March 1: buys 100 more debts for $800 each. April 1, sells 100 debts at 900 each. 1. Convertible security count as equity securities: 5,000 debts convert to 500,000 shares *which is 33% of common stock convert to determine BO 2. March 1: She is BO; April 1: She is still BO- both matchable 3. Liable for 100 debts x $100= 10k v. 5. Class A stock: 1M shares; Class B stock: 1M shares. March 1: Investor buys 110k Class A at $10, March 2: She buys 50k Class B at $10. April 1, sells all for $50. 1. Being a 10% holder of any class of stock makes you liable under 16b for all classes 2. March 1: not matchable; March 2: Matchable; April 1: Matchable a. 50k x 40= 2M liability b. Can only match within classes III. 16b generally: bright line rule that is under & over inclusive- supposed to be insider trading but covers insiders who are not real insiders (10%) a. Anti-manipulation rule: proscribes insider trades of a certain type & beneficial owner trades of a certain type trades that affect the market Accountability: Voting- SH right to vote I. Annual meetings & voting a. SH vote on elections, adopt amend or repeal bylaws, remove directors, adopt SH resolutions that can ratify board actions or request board take certain actions i. Note: Any directors may be removed w/o cause by any SH entitled to vote unless certificate says board is staggered & can only be removed for cause b. Annual election (211): default that this is election of entire board (unitary board election) usually through mail via proxy i. Staggered Boards: makes more difficult for SH, even with majority, to gain control of board of directors have to win 2 elections and might be long time between them

ii. Unitary board: SH has a chance to elect a full board once a year c. Special election (211d): SH cant call a special election, unless provided fro in bylaws or certificate of incorporation d. SH Action by written consent (228): SH can solicit consents even when they cant call meetings e. Annual meetings: Flexible- state statutes usually have min/max notice period & a quorum (prevent a minority faction from acting at a SH meeting w/o presence of majority) requirement for general meetings II. Voting & Takeover Protections for incumbent board a. Protected: Ability to call special meeting (default rule); staggered board (can put in charter), no SH action by written consent (in bylaws or charter) i. Special Meetings: Called by board (or authorized in charter/bylaws); holder of at least 10% of votes may demand a meeting in writing usually SH vote on fundamental transactions (211d) 1. Can amend the charter, elect directors; cannot be used to takeover board ii. Staggered Board: Elect every 3 yrs some of the board and each person serve 3 yr term; Advice- put in charter so SH cannot change b. Vulnerable: annual election of directors; SH action by written consent i. Default annual election: more vulnerable to takeover than staggered board (211b) ii. SH action by written consent: ability to take SH action w/o calling a meeting; consents act like votes and can solicit anytime (228a) 1. Put in certificate of incorp that there cant be SH action by written consent III. Problems of Control- Proxy Fights: election occurs through proxy system a. Proxy Voting: SH appoints a proxy agent to vote his shares at the meeting- you tell agent what to do through proxy card (specify how shares voted or broad discretion)- revocable with written notice to corporation w/intent to revoke, appointing another proxy holder or appearing in person Creates agency relationship i. SH Meeting require a quorum (majority) to act: use proxies (state law guides) b. To solicit proxies, management sends to SH at corporate expense a voting packing containing an annual report, proxy disclosure statement, proxy card, and return envelope i. Proxy context: may reimbursed for expenses if you win 1. Levin v. MGM: Ps sued MGM & 5/13 members of board. Ps charged Ds in connection w/the proxy solicitation contest, wrongfully committed MGM to pay for services of attorneys, PR firm and proxy soliciting orgs, and improperly used the offices & employees of MGM in proxy solicitation & the goodwill and business contacts of MGM to secure support for the present management a. Issue: Whether unfair means of communications are being employed by present management b. Holding: NO. The amounts to be paid are not excessive and the methods of operation is not unfair or illegal c. Rule: Incumbents may be reimbursed from the treasury as long as it is a reasonable price, not illegal or unfair (So corp allowed to pay these expenses for proxy solicitation) 2. Rosenfeld v. Fairchild Corp: P brought deriv. suit to compel return of $20k paid out of corp. treasury to reimburse both sides in a proxy contest for their expenses. Insurgents win. a. Issue: whether management may look to corp. treasury for reasonable expenses of soliciting proxies to defend its position in a bona fide policy contest b. Holding: In a contest over policy, as compared to purely personal power, directors have the right to make reasonable & proper expenditures from corp. treasury for purpose of persuading SH of the correctness of their position & soliciting their support for policies the dirs believe in good faith are in the best interests of the corp. i. Directors need to freely answer challengers ii. Both sides are reimbursed

c. Rule: If $ spent for personal power or not best interests of SH, then not allowed 3. Levin & Rosenfeld stand for: a. Corporation may reimburse either party only if the dispute concerns questions of policy, as opposed to purely personal matters of control (not a big safeguard) b. Corp may reimburse only reasonable & proper expenses c. Corp may reimburse incumbents whether they win or lose d. Firm will reimburse insurgents ONLY if they win and ONLY if SH ratify the payment if they are challenged i. Rationale: want insurgents if they have better ideas but if not then this will be wasteful & will happen all the time ii. Kind of like BJR for board- as long as not self interested 4. 2 ways to get on board: Takeover or proxy contest IV. Securities Exchange Act Rule 14a: It shall be unlawful for any person by use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national sec exchange or otherwise, in contravention of such rules & regs as the commission may prescribe as necessary or approp in the public interest or for the protection of investors to solicit any proxy in respect of any security registered pursuant to section 12 of this title a. 14a: substantive regulations of process of soliciting proxies & communication among SH b. 14a3: incumbent directors must provide an annual report before soliciting proxies for annual meeting disclosure requirement to protect SH i. No solicitations unless complaint proxy statement is provided to solicitees c. a7: in a proxy contest, incumbent management must either mail the insurgents proxy materials for it or provide them w/the stockholder list equalizes access i. Anyone who solicits a proxy must provide a written proxy statement BEFORE soliciting the proxy ii. Solicit: not only direct requests to furnish, revoke, or withhold proxies, but also communications which may indirectly accomplish such a result or constitute a step in a chain of communications designed ultimately to accomplish such a result d. A8: SH proposal have to state: identity of SH, # of proposals, length of supporting statement, subject matter of proposal e. A9 (mirrors 10b5): Rule about fraud in connection w/solicitation of proxies i. No solicitation shall be made by means of any proxy statement containing any statement which at the time and in light of the circumstances which it is made, is false or misleading w/r/t any material fact or which omits to state any material fact necessary in order to make the statements there not false of misleading ii. Key elements: (1) Materiality; (2) Culpability- negligence, recklessness; (3) Causation; (4) Reliance f. Fed courts have inferred a private cause of action for SH if violation of proxy rules V. Shareholder Proposals: It is the companys burden to demonstrate it is entitled to exclude a proposal (14a-8g) a. Shareholders under 14a8: (1) own $2k of stock or 1% (lesser of the 2) for 1 year; (2) proposal 500 words or less (no website for more words); (3) send someone to a meeting i. Company seeking to exclude proposal seek SEC approval in form of no-action letter that says SEC wont take action if proposal is omitted 1 proposal per company/yr b. Rule 14a8g: Bases a company may rely on to exclude a proposal: i. 1-Anything a SH is trying to force a company to do is not a proper action for SH under state law 1. Business decisions are not proper for SH (Iroquois); amend charter, daily business operations, procedural actions ii. 2- Illegal iii. 3-Violates proxy rules iv. 4-Personal grievance or benefit (cant be about you getting fired)

v. 5-Relevance: Proposal may be excluded for irrelevance if it relates to operations which account for less than 5% of the issuers total assets and for less than 5% of net earnings and gross sales and is not otherwise significantly related to the issuers business 1. Not limited to economic significance: ethical is allowed a. Ex. Healthcare: if co. spends more than 5% + only aksing co. to study effect, not change national policy (look at 6) + great social concern (not 7) 2. Lovenheim v. Iroquois Brands: P wanted D corp to include in proxy materials a proposal to investigate the question of whether the fois gras that co sells is animal cruelty b/c ducks are force fed a. Issue: fois gras is less than 5% of cos business but is it otherwise important? b. Holding: D may NOT exclude the proposal. They have not met the burden. The ethical & social significance of Ps proposal and the fact that it implicates significant levels of sales may be viewed as significantly related to Ds business vi. 6-Matter beyond a power of a firm to effectuate vii. 7-Relates to the firms ordinary business operations (anything controversial is outside ordinary business ops) 1. Ex. Pension proposal to retire after 30 yrs regardless of age: may be excluded- setting benefits of employees is ordinary business operations- try to frame as national concern/broad viii. 8-Items that have been submitted in the past w/o getting much support c. 14a-8-i8-Relating to an Election: Can be excluded if the proposal relates to an election for membership on the companys board of directors or analogous governing body i. AFSCME v. AIG: P submitted for inclusion in proxy statement a proposal that would amend bylaws to require D to publish names of SH nominated candidates. D excluded proposal. 1. Issue: 14a-8i8: Allows exclusion if proposal relates to an election- is seeking to amend corp. bylaws to establish procedure relating? 2. Rule: SH proposal does NOT relate to an election for exclusion from proxy statement if it seeks to amend corp. bylaws to establish a procedure by which certain SH are entitled to include in the corp. proxy materials by nominees for the board of directors ii. SEC REWROTE THE RULE: can be excluded if the proposal relates to a nomination or an election for membership on the companys board of directors or analogous governing body or a procedure for such nomination or election iii. 14a-11: Holder of 3% for at least 3 years and continue to hold through election; no change of control intent; independence of management; notice required 1. NO LONGER EXISTS: constitutionally challenge- no valid policy objective & arbitrary d. Common SH proposals: i. To remove poison pills ii. To require annual election of all directors iii. To require that directors hold a specified minimum amount of corp. shares iv. To prevent the same person from being both CEO and chair of the board v. To require that a majority of the board and all key committees to be independent directors vi. To link director pay to corporate performance vii. To require that compensation committee be composed entirely of independent directors w/ its own compensation consultant viii. To create a committee of SH to advise the directors VI. Shareholder Inspection Rights SH have to be informed in order to vote intelligently a. DCGL 220b: Any stockholder, in person or by attny or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies & extracts from: the corps stock ledger, a list of its stockholders and its other books & records i. Proper purpose: reasonably related to such persons interests as a SH (broad) 1. 220c Burden allocation:

a. If SH seeks access to SH list burden on corp to show improper purpose (easier to produce the list) i. SH List: to help voting- gives identity, ownership interest, address of each registered SH b. If SH seeks access to other corp records burden on SH to prove proper purpose (harder, more costs) i. Books/records: To sell or sue ii. State corporate law leaves function of informing SH largely to the market b. Proxy Contests: i. SEC 14a-7: In proxy contest, incumbent manager must either: 1. Mail insurgents proxy materials for it 2. Provide insurgent w/copy of SH list ii. SH litigation: you want to talk to people directly so may file deriv. suit 1. Grimes v. Donald: SH filing deriv suit must allege either that the board rejected his pre-suit demand that the board assert the corps claim or allege w/particularity demand futility c. Crane Co. v. Anaconda Co.: Tender offer is a business purpose i. Facts: Crane proposed an offer to exchange $100mil in subordinated debentures for up to 5 mil. Shares of common stock of Ana. Ana opposed ths and sent letter to SHs stating that. Crane requested list of SHs claiming they had a FD to present them w/all the info pertinent to the pending offer (Crane owned no Ana stock at this time but they after bought stock to make them the largest SH & requested again. Ana said Cranes reasons for inspecting book werent purposes related to the business of Ana w/in 1315 of Business Corp Law ii. Holding: A SH who wants to discuss relevant aspects of tender offer should be granted access to SH list unless it is sought for a reason unfavorable to corp. Ana did not prove improper purpose. Whenever the corp. faces a situation having a substantial effect on its wellbeing or value, the SH are necessarily affected and the business of corp is involved w/in 1315. iii. Rationale: Inspection of books allows SH to independently evaluate situation 1. Statute construed broadly in favor of SH whose welfare may be affected a. Shares are tendered in an escrow acct pending completion of the contingencies- usually contingent on getting certain # of shares (51%)- to buy control of company b. Tender offers usually made at premium price- so buyer thinks they can do something to make co worth more c. DE Standard reasonably related to your interest as a SH (offer to buy shares is related) d. NY standard Business purpose (offer to purchase goes to ownership of shares, not business of the co.) i. NY: SH have statutory right to inspect key financial statements, balance sheet, income statement; Stock list and meeting minutes available unless company can show no proper purpose d. Inspection Purposes: i. Proper: Investigate alleged corporate mismanagement; collect info relevant to valuing shares; communication w/fellow SH in connection w/a planned proxy contest (attempt to take control) ii. Improper: Attempted to discover proprietary business info for the benefit of a competitor; secure prospects for personal business iii. Interpreting proper purpose: 1. Pillsbury v. Honeywell: protesting manufacture of things for the war a. Public policy issue of things public would want to know improper b. Adverse effects in public as result of manufacture Proper (BRING BACK TO INVESTORS to create proper purpose- SH Economic interest!) VII. Vote buying: SH cant sell vote other than as part of transfer of the share, unless you specifically retain the right to vote; warrants: rights to purchase stock at fixed price and valuable b/c common stock price exceeds exercise price a. Courts have allowed transfer of voting rights when related to otherwise legit corp transaction

Control in Closely Held Corporations- Rights: Vote, Sell, Sue BUT no one to sell to I. Cumulative Voting: SH voting power= # shares x # seats on board every share entitled you to vote for each seat on the board, so you can pile up votes & put it behind a small number of seats. This allows min. SH to accumulate votes and allocate them (ex. 7 seats on board, each share gets 7 votes) a. Close corps: small $ of SH, no ready market for shares, substantial majority of SH participate in corp b. Ringling Bros. v. Ringling: i. Facts: Ringling & Haley enter into K that they vote together w/all of their shares. If they fail to agree, the issue will be arbitrated an tell them how to vote. An election came & they didnt agree on 5th director and Haley voted the opposite way of arbitrated decision. ii. Holding: Pooling agreement was binding & valid. Failure to vote arbitrator way is breach of K, even though arb didnt have the power to cast the votes. 1. Election not invalid but Haleys votes rejected. iii. Rule: Voting agreement are valid but cannot be permanent- only for a term II. SH cannot form an agreement to control the decisions traditionally vested in the judgment of directors of a company SH may contract to elect each other as directors if they are the ONLY shareholders (cannot create a duty only to some SH) a. McQuade v. Stoneham: M entered into K w/S &MG that they would keep each other as officers of the corp. But there was a falling out and at next election M lost. i. Holding: S & MG duty was to corp & stockholders. The K was illegal & void as it precludes the board of directors, at risk of incurring legal liability, from changing officers, salaries or retaining people in their officer except by consent of contracting parties. ii. Rationale: Directors have a duty to ALL shareholders, not just the ones who votes for them 1. Pre-committment is a problem: You have FD as director & pre-commitment is unenforceable if it violates FD b. Unanimous Consent: If directors are SOLE stockholders, there is no objection to enforcing an agreement among them- public is not effected so parties can limit their rights (no conflict problem) i. Clark v. Dodge: C & D are sole SH of 2 corps. C owns 25% of both & D owns 75% of both. They enter into K that C would manage corps & get 25% of earnings as long as he was faithful & competent and he would tell the secret formula to Ds son. D failed to continue C as director & prevented from receiving income 1. Holding: No other SH so K is valid. As long as all SH are party to the K or their waive their rights, the K is enforceable. c. How could McQ & Clark gotten what they wanted w/o risking contractual invalidity? i. Find a mechanism to pre-commit the company at the time you enter into K (licensing agreement) ii. Separate voting agreement (as shareholders) from employment contract (between individual & corp) d. Rule: Agreements between all SH to keep each other as directors, etc. are legal if all SH agree and it does not harm creditors or the public (Clark v. Dodge) e. Rule: Agreements between SH cannot eliminate the directors FD Still allowed to fire w/agreement if director is seriously neglecting their duties III. Position of minority shareholder in close corps: No right to demand dividends; No right to a job; The controlling SH can work for the corp and pay themselves generous (but not excessive salaries) a. Close corps have lots of internal issues: no market to sell interests, so minimum SH is at mercy of majority- no may to get money unless you get dividend or salary b. Controlling SH can act to detriment of minimum SH- power to select board to approve fundamental changes- Courts impose FD on them like partners c. Freeze out: isolates minority SH from corporate participation (forces them to sell shares to majority on unfavorable terms) i. Majority can remove min from office, deny compensation, impose no-dividend policy ii. Minority rule: Focus on intent: to just rip these people off 1. Contrast w/partnership: if partnership, the min SH could withdraw & dissolve the ptnrship and if not wrongful, is entitled to liquidation of business & payment for proportional share

d. Wilkes v. Springside Nursing Home (Mass. Ct)- Illegal Freeze Out- MINORITY RULE (Facts: Fired + paid no dividend) i. Facts: 4 men buy property, operate it as a nursing home, and vest ownership of the property in a corporation. At time of incorporation it was understood that each party would be a directors and manage and operate the corp. Wilkes had falling out and wasnt re-elected as director or officer. ii. Issue: Can Wilkes get damages for breach of FD to him by other managers? iii. Holding: the controlling group has to demonstrate legitimate business purposes for their actions. They dont have any b/c no misconduct by Wilkes so they breached their FD to him as minority stockholder 1. 2 part test: Nothing like BJR Majority SH cannot act out of avarice, expedience or self-interest (DOL) a. Controlling group must show legit business purpose for the action b. Minority may rebut by showing alternative course of action less harmful to the minority 2. Stockholders in closely held corp owe each other same FD as partners own to each other (may not act in self interest) iv. Why did court do this? Wilkes bought his shares as minority SH and this was foreseeable so he had the option to bargain for a L 1. Employment agreement; bargain for buy-back option in the event something happens to buy back at high price 2. Did Wilkes get more than he bargained for? This is about intent- ripping him off on purpose COURT IS REWRITING THE CONTRACT a. Should have had a plan to arbitrate deadlocks b. This turns at will employment to for cause c. May not act out of avarice, expedient or self interest in derogation of their duty of loyalty to the other SH 3. If they argue legit purpose by cost saving- he could say we can save costs elsewherethis is NOT a rule a court should make- He invested on these terms v. Mass SJC Close corp definition (LOOK ON SLIDE) e. Smith v. Atlantic Properties, Inc.: Where charter has a provision to protect minority SH, the minority SH have FD to use provision reasonably i. Facts: Wolfson bought land & went in with 3 others, so each owned 25%. In articles of incorp & bylaws made that everything needed to be approved by 80% (supermajority provision). There was a disagreement w/group & Wolfson- he wanted to do improvements and they wanted dividends. The co got tax penalties b/c they didnt pay dividends. 1. Wolfson didnt want dividends b/c he would have to give 90% to gov b/c he is rich ii. Issue: Did Wolfson breach FD to other stockholders? YES iii. Holding: Even if Wolfson had a reason to refuse to declare dividends, he recklessly ran serious & unjustified tax penalties- breached duty of good faith & loyalty with his risks. So he pays out of pocket for costs incurred 1. Controlling SH owe FD to minority SH: 80% provision makes them all controlling SH so they all owe FD 2. Griffith thinks this logic is nuts: They are all responsible b/c they vetoed his proposal to improve property which would have avoided the tax penalty- they ALL held out so case should be dismissed 3. We force min SH to K around the default rule b/c the requirement to pay or give jobs would be expensive & these are small businesses. No one wants a rule that makes it impossible to get into business f. Review: What did Ds do wrong? i. Wilkes: cut of W salary & offered low prices for shares ii. Smith: Blocked payment of dividends & failed to produce a sound plan for investment of retained earnings iii. Planning techniques to avoid litigation: 1. Wilkes: Create buy-sell K; employment K; shareholder agreement

2. Smith: buy-sell k; arbitration in case of impasse; dissolution in case of impasse Public Company Control: Takeovers I. Friendly Change of control: Most control changes occur in negotiated or friendly acquisitions, where management of two corps bargain over structure, terms and future management. After the boards approve the deal, it is submitted to SH of acquired co for approval (or both SH if merger) a. BUT when Corp is publicly held, a suitor can go over the heads of unwilling management and woo the SH directly. 3 ways to do this: i. Proxy Contest: BY soliciting their proxies to oust the incumbent board and instill the suitors slate of directors ii. Tender Offer: Suitor can appeal to SH wallets by seeking to buy a controlling block of shares at above-market prices. A successful tender offer gives the bidder a majority equity position and assurance of control- unlike proxy. iii. Combined proxy contest/tender offer (TWO STEP): Suitor can solicit proxies to replace the board, on the promise that it will make a tender offer b. Greenmail: Buying your stocks back from someone else who has your shares (it is a defense) say this is bad practiced and not allowed b/c it is in exchange to make threats go away i. Bought at a premium: structurally ineffective anyway c. Takeovers: Best market to make managers want to do well and have high stock price II. Ways to Buy a Company: a. Buy the Stocks/Shares: Buyer company sells shares to SH, just like merger. No involvement of board of directors of target company ONLY FORM THAT CAN BE HOSTILE (where target board may not way transaction) b/c the board cannot prevent SH to sell shares to target company. i. 1 tax: SH on value of their shares (for target co SH) ii. Buying Shares: Tender Offer: Conditional offer to purchase w/bidder offering to buy a certain number of shares (usually 51 %) Not binding on bidder unless all conditions are met and usually gives it voting control iii. Buyer company becomes owner of target company b. Buy all the Assets: Buyer company pays the company an amount over the consideration between the 2 companies. Seller co delivers assets to buyer co. Seller co has cash from buyer co and liquidates and gives cash to seller SH. i. Seller, by vote of the board & SH, Agree to sell all of its assets (DGCL 271a) 1. Gives target co SH a right to vote on the transactions 2. SH Exit Event- Monetizes their investment 3. Typically seller liquidates and distributes consideration to SH 4. Avoids buyer assumption of liabilities on seller ii. Double taxation: 1. Sale of assets is a taxable event: Tax at the corporate level based on the difference in the depreciated tax book value of the assets sold and the sum of the purchase price and liabilities assumed 2. Taxed when SH get paid: Assuming liquidation based on the difference between the tax basis of the SH stock and the liquidating distribution iii. NOTE: CANNOT BE HOSTILE- Board needs to approve c. Merger: Company A pays w/its own shares. B shares convert into A shares at an agreed upon ratio and B shares are cancelled. So B SH becomes A SH. The Companies & their boards agree to the plan of merger i. NOTE: Cannot be hostile- Boards negotiate this ii. Merger is an operation of law: At closing, the certificate of merger is filed w/the secretary of state, giving it legal effect iii. DGCL 251: Transaction must be approved by SH of BOTH COMPANIES 1. 251c: Agreement required by subsection b of this section (merger k) shall be submitted to the SH of each constituent corp at an annual or special meeting for the purpose of acting on the K 2. Is there a way around this for the SH of the acquiring corp?

a. Triangular mergers: Acquirer forms wholly owned subsidiary where bidder owns 100% shares and then merged w/the target corp= does not assume liabilities of the acquired corp (merger between acquisition subsidiary and target corp) i. SH of targeting company have to vote ii. SH of acquiring subsidiary vote: They are the board iii. Bidder creates acquisition subsidiary in which bidder owns 100% of shares, so the merger is between acquiring subsidiary and target corp iv. LOOK AT SLIDE v. Target SH gets consideration directly from bidder, not subsid b. Forward Triangular merger: Where acquiring subsidiary survives c. Reverse Triangular Merger: Where target company survives (subsidiary is merged into target and assets of subsidiary are exchanged for assets of targetso target becomes subsidiary of the parent and SH of target get consideration) i. Cheapest & easiest b/c leaves both pre-existing corps in tact 3. Voting common stock of the target corp have voting rights on a merger except: a. The surviving corps charter is not modified b. The Security held by surviving corps SH will not be exchanged or modified c. The surviving corps outstanding common stock will not be increased by more than 20% iv. Legal Consequences of Merger: 1. Survivor automatically succeeds title to all assets. a. DGCL 259: Survivor automatically liable for debts of both corps 2. DGCL 262: Dissenting SH may get appraisal rights (right to sue that money you got from merger is inadequate)- they have to object to merger a. 262b Appraisal Market Out Rule: Get appraisal rights in statutory merger b. BUT b1: Do not get appraisal rights if your shares are market traded of the company has 2k SH or SH not required to vote on the merger c. BUT b2: DO get appraisal rights if your merger consideration is anything other than shares in the surviving corp or shared in 3rd corp that is exchange traded or has 2k SH with de minimis exception for cash in in lieu of fractional shares 3. So statute restores appraisal remedy if target SH receive consideration anything other than: stock in surviving corp, any other shares, cash, or combination v. Short form merger: parent corp that owns 90% or more of shares of subsidiary corp may merge it into the parent w/o SH vote of either court- SH of subsidiary have right to receive appraisal d. Notes on Mergers (not sure if we did but helps understandinged i. May contain special provisions: Lockup (protect friendly deals from hostile intruders) ii. Timing: all cash multistep is fastest iii. Leveraged Buyouts: private corps acquires all outstanding shares of public corp so it is no longer publicly owns iv. Appraisal Remedy: Exclusive remedy of minority SH in short form merger III. Hostile Takeovers: NOTE: IF no hostile takeover initiated, apply BJR a. Cheff v. Mathes: i. Facts: Marmont (Motor Products) wants to buy Holland. Board said no so he kept buying more shares. Holland did not want to change its system of sales & Marmont would do that. To make sure takeover did not happen, Holland used corporate funds to buy stock owned by Motor Products and paid more than market price. SH due derivatively to hold board liable for loss from improper use of corporate funds to purchase shares of the company. 1. Two tier tender offer: Front end, buyer gets 51% stock and then the back end gets a loser price- so it basically forced merger to occur ii. Issue: Whether purchase was allowed- purpose for perpetuation of control of incumbent directors, then it is not.

iii. Holding: Burden on board to show reasonable grounds to believe a danger to corporate policy & effectiveness. B/c they showed reasonable threat to continued existence of Holland, so defer to BJ and Ds win. 1. Standard: Good Faith of Reasonable Directors to believe a danger to corp.: If board has acted solely or primarily b/c of the desire to perpetuate themselves in office, the use of corporate funds for such purposes is improper and breaches the DOL. a. Burden on Board to show business purpose QUESTION IS BOARDS INTENT b. This is allowed as long as entrenchment (perpetuating themselves) is not the SOLE OR PRIMARY MOTIVE 2. Defensive measure: Greenmail- buyback of shares iv. General rule: Defensive devices permitted as long as the action was motivated by a sincere belief that the action to maintain what the board believes are proper business practices 1. That they are not solely to perpetuate the board in office b. Unocal Corp. v. Mesa Petroleum: i. Facts: Mesa commenced front loaded tender offer (front end cash, back end junk bonds- so better for first people). Unocals board met to consider the offer and decided to make an exchange offer. Mesa sued for that and for excluding them from buyout. ii. Issue: The validity of a corps self-tender for its own shares which excludes from participation a SH making a hostile tender offer for the companys stock iii. Holding: Corp has burden to show valid business purpose & transaction was fair to all SH including excluded ones. Board is mostly independent directors who acted in good faith and after reasonable investigation that Mesas tender offer was inadequate and coercive. Under the circumstances, the board had the power & duty to oppose bid that it perceived harmful to the corp. 1. Mesa would merge Unocal w/Mesa and b/c he would own 51%, he would assure SH approval 2. 2 Tier tender offer: creates incentive to tender & back end would be screwed 3. Unocals response: Self tender at $73 to everyone but Mesa- also 2 tied but the back end would be shares, not anything bad. BUT Unocal is getting money from the corp to pay so the shares are worthless 4. Exclusionary Self Tender- No longer allowed iv. Two-Part Test: Incumbent Board must Show: (1) Threat + (2) Proportionality- that the defense measure was reasonable in relation to the threat posed to the corp 1. Intermediate Scrutiny (More than BJR but less than entire fairness): recognizes the inherent conflict in takeover defense 2. Threat: Reasonable perception of threat of harm to SH a. Burden on Board: Directors must show they had reasonable grounds for believing that a danger to corp policy and effectiveness existed b/c of another persons stock ownership good faith + reasonable investigation i. If response if preclusive or coercive (Draconian) fails ii. Structural coercion: back end junk bonds iii. Substantive coercion: consideration is grossly inadequate b. What sort of threats? i. The bids effect on the corporate enterprise including: 1. Inadequacy of price offered 2. Nature and timing of offer 3. Questions of illegality 4. Impact on other constituencies (creditors, customers, employees, maybe even community generally) 5. Risk of no consummation 6. Quality of the securities being offered in the exchange 3. If defensive reaction fails either prong, the court invalidates the defensive tactic as a violation of the boards FD

c. SEC Rule 14d-10: All holders rule: No one can make a tender offer unless the tender is open to all holders and everyone has to get the same consideration (eliminates 2 tier tender offers) i. SEC Response to Unocal: No exclusionary tender offers & Fed overrules state law ii. Note: Between 1985 and 2000, every court found a cognizable threat & rarely found disproportionate d. If contest for control is self interested- need to show intrinsic fairness IV. Defensive Devices to Takeovers: no more exclusionary self tenders a. Crown Jewel Lock Up: When the co agrees to sell the best asset to another buyer- not available to the other buyer- and the first buyer will then buy the rest since the best asset sale brings the value of the firm down . (Revlon agrees to sell off one of its finer depts. To prevent Perelman from buying the co) b. White Knight: Merge w/someone you like- you pick an acquirer you prefer- usually allows incumbent board to keep their jobs (also in Revlon- FL would have let them stay)- so makes it impossible for hostile bidder to buy c. Pac Man: You borrow money and buy the person who is trying to buy you d. Golden Parachutes: Give officers really expensive termination provision so it is hard for someone to buy them b/c of extra costs. Also incentive alignment- problem is conflict of incumbent board, but they would get a high buyout so they accept the takeover. e. Poison Pill: Target company issues rights allowing SH (other than bidder) to convert the right (to buy shares) into a large number of common shares if anyone acquires more than a set amount of the targets stock (usually 20-30%). This dilutes the % of the target owned by the bidder, and makes it more expensive to acquire control of the target. One of the most important defenses i. When issued, it has no economic value b/c the price you have to pay to get shares is more than they are worth. BUT there is a triggering event- when acquiring person takes a stake- and the rights are triggered and exercisable at a different rate and everyone gets a 2 for 1 buy rate 1. Once triggering/distribution event occurs (announcement of intent to acquire) rights can be traded independent of stock (but no sense to exercise the rights) 2. Flip in: triggered by actual acquisition of 20% of shares: holder of rights (except acquirer) can buy 2 shares of issuers (target) common stock at price- dilutes value of target stock owned by acquirer 3. Flip over: if acquisition takes place, holder of right is entitled to purchase common stock of acquiring company at half price- impairs acquirers capital structure ii. Can be made overnight- board can make unilaterally w/o SH approval. It makes it so expensive for someone to buy from SH so acquirer is forced to negotiate with board who can redeem or remove the poison pill iii. Purpose: give the board a veto over the tender offer when they could not have done anything before. They can promise not to in articles of incorp. iv. Way to get around it: Once a co makes pill, turn it into a proxy fight/take over- If you win, board redeems pill and then you launch tender offer 1. Defense against that: staggered board_ you cant get the board in 1 election. No lender would promise the same terms and cant keep financing. SO PP + Staggered board= cant be taken over 2. Staggered board IN CHARTER- SH APPROVAL a. Amendments to charter: SH have to approved b. So Staggered board is hard to get 3. Ways to acquire company that has PP? Buy shares, vote on your directors, proxy fight, put your directors on board to redeem poison pill then do tender offer a. Dead hand poison pill: Can only be removed by current board of directors (DE SC Disallows this) v. Extremely effective means to prevent someone from buying shares: Only 1 modern PP triggered for tax purposes 1. Effect: Dilutes acquiring person to prevent purchase of shares V. Revlon Inc.: POISON PILL a. Facts: Battle for control of Revlon. R wants to sell company to Forstman (b/c he would let managers stay) but Perelman want his company, Pantry Pride, to take it over. Revlon thought his offer was too

low so they created a PP. Pantry raised their bid but Revlons directors approved the buyout by Forstman exclusively. i. Unsolicited hostile bid for Revlon Adopts PP and issues notes Pantry raises bid price Revlon finds white knight (F) Pantry promises to outbid white knight Revlon negotiates crown jewel lock up with white knight b. Issue: There was an injunction to stop k w/F. Perelman sues w/SH claiming that board breached FD to SH by looking out for their own best interests to prevent litigation from note holders by sacrificing interests of SH. c. Holding: Initial defensive tactics by board were okay b/c they worked for the benefits of the SH. But in agreeing to the lock up w/F, the directors allowed other factors other than SH maximization to inform their decisions. Instead of trying to get the highest purchase price, they took F to limit their personal liability. SO BJR does not apply and Ds enjoined. i. Rule: Once buyout became inevitable, the directors duty changed from preservation of Revlon as a corporate entity to the maximization of the companys value at a sale 1. Once Pantry increased offer, break up of co was inevitable 2. So board cant think about note holders, creditors, or others except SH 3. Reason: This is the last chance SH have to monetize the investment- turns shares to dollars and board has special duty to maximize SH wealth ii. Court focuses on triggering event of special duty: Cash Sale Break up of Co once breakup is a reality, board must get highest price 1. Authorization permitting management to negotiate the merger or buyout w/third party recognizes company is for sale 2. B/c board no longer faces threat to corporate policy & effectiveness, question of defensive measures becomes moot d. Revlon & Unocal Duties: i. If the Company is for sale- Revlon duties: Strict SH Maximization 1. How may/must a board act when it decides to sell the co a. Once the break up of the company has become a reality, which even directors embrace, selective dealing to fend off a hostile but determined bidder is no longer a proper objective. Instead, obtaining the highest price for the benefit of the SH should guide director action b. Applies when: Corp initiates an active bidding process- a clear breakup i. Target abandons Long Term strategy and seeks alternative transactions involving breakup c. Triggered when: Change of control (Cash or bust of deal); last chance to monetize the investment 2. No need to auction every time: Just a rational process to produce the highest value for its SH- some justification to say it got the best price (market check) ii. If the company is being defended from hostile takeover Unocal duties 1. How may/must board react when it gets an unsolicited offer VI. Paramount v. Time: Means a board CAN just say no if a previous business decision a. Facts: Time wanted to merge w/Warner. First, they were going to do stock for stock exchange (which would require SH approval under NY law). Paramount came in w/higher bid & to buy the whole company. Time decided to do cash only to avoid SH vote (under triangular merger rule). Paramount sued. b. Issue: Do Unocal or Revlon apply? c. Holding: i. Revlon does not apply b/c Time isnt going to dissolve this is a stock deal, not cash deal to monetize. Here, you are SH, transaction happens, and still SH 1. If applied Revlon, would lose b/c Time is target of Paramount and they are totally refusing to sell to them. Also, Time Culture is non-SH constituency 2. Under Revlon, only allowed to think about SH ii. Unocal applies (threat): There was a reasonable threat that the SH wouldnt be informed enough to vote (and this motivated the boards decision, not entrenchment) & the response was proportional b/c they didnt say Paramount could not acquire Time-Warner after merger.

1. Time wants to control (remain directors) to keep Time Culture- serious publishing house and cant be eroded by entertainment co- keep journalistic integrity a. OR Omnipresent specter of entrenchment: someone will control & Time wants to b/c they dont want to give up their jobs so they make up a reason to legitimize it 2. Defensive Devise: Restructured transaction so SH do not get vote at all 3. Threat: a. Ps argue: Paramount was a whole deal. Not 2 tier structurally coercive like Unocal, so no coercion b. Ds argue: Concern that Time SH might elect to go to Paramount in ignorance. In the long run, the value of the plan far exceeds the Paramount deal. They want to keep the journalistic integrity of Time that is worth more. i. Market price is the best guess of what the co is going to be worth in the future (not good justification) ii. Threat is great & afraid SH will make bad decision c. Proportionality: i. Ps say: What is a proportional response to 50% premium bid- taking away SH vote? Even if it is a threat, they should educate SH about future value ii. Court says: It is proportionate b/c once they merge Paramount can buy the company. Also, this is a continuing of Times business and carrying out a previous business decision 1. BUT Para doesnt want Warner, only time. Also, would need to raise 2x as much cash VII. Paramount v. QVC: a. Facts: Paramount wanted to be acquired by Viacom. There were poison pills, no shop provisions, etc. Then QVC came in with a bid to acquire Paramount. Para said they could not consider b/c of contract w/Viacom and has preferential negotiations w/Viacom. b. Issue: Does Revlon apply? c. Holding: Revlon Applies- Not a sale but a change of control (NEW TRIGGER FOR REVLON DUTIES). That means board has to do what is reasonable and in best interests of SH duty to strictly maximize SH welfare- design process to reasonably extract highest value i. Merger (Acquisition) Agreement: Paramount board stays in control. Viacom gets: Pill redemption, lock up options (20%), no shop/no talk, termination fee 1. This is a stock for stock transaction (like Time Warner) ii. Change of control: A deal that causes a diffusely held co to come under the control of an individual group 1. When a majority of a corps voting shares are acquired by a single person or entity or by a cohesive group acting together, there is a significant diminution in the voting power of those who become minority SH 2. If no change of control: More deferential standard (Time- both cos diffusely held so the control of the corp is not vested in a single entity or group) 3. Following this transaction, there will be a controlling SH who will have voting power (to elect directors, cause a break up of corp, merge w/another company, cash out to the public SH, amend COI, sell all or substantially all of corp assets) 4. Irrespective of present Paras board vision of long term strategic alliance w/Viacom, the proposed sale of control would provide new controlling SH w/the power to alter that vision 5. Once control has shifted, the current Para SH will have no leverage in the future to demand another control premium 6. SO: BOARD OF DIRECTORS OF PARA OWE HIGHER DUTY TO SH FOR STRICT WELFARE MAZIMIZATION iii. What should board do when confronted w/a hostile takeover? 3 possibilities

1. Should have full power to defend co as much as they want from takeover: Directors know companies better than SH (Lipton)- assumes markets do not accurately price shares 2. Total passivity: Board cant do anything while SH decide whether to sell would maximize takeover and takeover market is incentive mechanism for managers to runt he company as well as they can so shares will be high and takeovers wont happen (Easterbrook/Fischel) 3. Middle/Revlon: Takeover defenses are ok as long as used to get the highest objective value: Pretty much can do anything as long as not in revlon d. Note: DE courts gets involved in certain takeover situations b/c all their revenue comes from taxing out of state companies who file papers in DE so they need to appeal to managers and to people making decisions BUT need to be involved when agency costs where managers may not be maximizing SH value. e. For takeover Ws: How much a corps board behave when it gets an offer to buy the co? i. Look to Unocal, glossed by Time Warner ii. How may a corp behave when it decides to sell the co? Revlon Accounting Concepts I. Balance Sheet: Statement of what the business has at a particular moment- financial overview a. Assets it holds, liabilities it owes, difference between the two is the equity that the partners have in the firm (assets = liabilities + owners equity) b. Assets & liabilities sum to 0 c. Assets= resources w/probable future economic benefits obtained or controlled by an entity resulted from past transactions or events i. Listed from most liquid to least liquid (cash, accts receivable, inventory, land) d. Liabilities: debt or legal obligation i. Listed in order when the obligation will come due (accts payable, taxes payable, accrued interest, etc.) e. Owners equity: residual interest in the companys assets after debt & obligations II. Income Statement: reflects the net income of a business in particular periods and is regularly renewed over a period of time a. 3 main components: revenue expenses= net income/loss i. revenue: amount of money received by company thru sales during a prd of time ii. expenses: money spent or costs incurred in companys efforts to generate revenue iii. net income/loss: profit/loss of company over period of time b. Revenues-costs of goods sold= gross margin fixed costs = operating earnings taxes & interest = net income c. Net income becomes the equity & retained earnings on the balance sheet III. Cash Flow Statement: indicates changes in cash position over a period of time a. Begin w/net income/loss and adjust for: non cash items, investing, and financing activities b. Used to asses liquidity/solvency- measure of financial heath c. Business can be very profitable but insolvent (high cash expenses, sales on credit) IV. Add in problems? V. Matching principle: match expenses w/related revenue VI. Conservatism principle: recognize revenues and assets when they are assured of being received; recognize expenses & liabilities as soon as possible when there is uncertainty about the outcome SEC COMMISSIONER TALK: Troy Paredes I. Generally: a. 5 commissioners appointed from pres w/advice and consent of Senate b. Consumer Protection act- significant overhaul c. SEC administers them as an active agency- court influence (Roberts) i. Cases: Mark, Morrison, Hallburton II. Disclosure: use it to promote transparency a. Better when investors can make informed decisions

b. Fed Sec laws mandate certain disclosures c. Need to refine the regulatory regime to allow businesses to raise capital more privately- more efficient and lower cost d. We are better off when businesses can raise capital- helps create jobs III. Over disclosure: Might to too much for investors to work through efficiently a. They will be unable to distinguish what is important and what is not- may be overwhelming b. More disclosure can result in less transparency & worse decisions IV. Dodd-Frank a. Disclose: executive v. firms performance; total compensation v. ceo compensation; whether co has separate chairman of board and ceo V. Commissions should consider impact on investors as disclosure increases- might be better to have shorter, more valuable, more targeted info a. Need to weigh costs/benefits of more disclosure b. Some mandatory disclosures may not be warranted VI. Q&A: a. Regulators draw lines: function of policy preferences and tradeoffs b. Move from US GAAP to IFRS cost justified? Value of having international standard- easier for investors who only need to understand 1 set of accounting standards- drives down costs of capital and preparation but transition may not be easy i. Does every US issue have to move to IFRS? Larger multinational cos are ready to make the change but smaller public cos dont need the value NEED TO ADD: PROBLEMS PROBLEMS: I. Problem 1: Retro Fitness Franchise- want to avoid franchise liability in tort a. Indemnification & insurance b. Franchise agreement controls the legal structure c. Operating manual: tells them what to do- do not incorporate into franchise agreement, but phrase it was suggestions, otherwise might be a binding contract d. Notice to 3rd parties- put up signs e. Liability Waiver f. Contractual Disclaimer: this agreement does not create the relationship of P & A between franchisee. Franchisee is independent contractor. This only operates between franchisee and franchisor, not third parties. i. No holding out: Say in K that franchisor cannot say they are your agent ii. They have the right to control their own expenses iii. Provide the forms iv. Limiting instructions that no franchisee can enter into contracts g. Additional facts we need to ask? i. Is there express authority in the K? Does this fall w/in implied authority? ii. Did she represent herself as an agent and it was reasonably they relied on this? h. Apparent Authority problem: i. Contract that you are contracting w/franchisee and not franchisor ii. Imdeminification contract iii. Business forms to franchisee explicitly stating Retro is not involved 1. Specific vendors for certain products: only approved vendors who have notice i. Retro Laundry? i. Given the money might be ratification- needs notice II. Problem 2: How to deal with deadlock a. Avoid 50% (give one 51%)- but economic interest not always tied to control interest b. Grant 1 partner tie breaking vote c. Arbitration provision: Expensive, need to work out procedural aspects d. Buyout provision: Who gets to buy, set the price (problem of valuation)

i. Golden rule alternative: Incentive to submit fair price when both parties submit price and whoever has the higher bid gets it e. Dissolution clause III. Problem 3: Pfizer Litigation for substantial benefit to SH a. Governance Changes: establish regulatory committee and set logistics for implementation of it; delineate responsibilities between audit & regulatory committee; establish ombudsman (employee work concerns); regulatory committee collaborates w/compensation committee; compensation claw back IV. Problem 4: SH Proposal on Mandatory D&O Disclosure a. Cant tell directors what to do but can propose bylaws LISTS OF FACTORS FOR EXAM I. Piercing the corporate veil: Subsidiary & Parent a. Page 208 II. Factors of Control a. Cargill b. Holiday Inn III. Precautions allows that do not arise to partnership w/creditor a. Martin v. Peyton IV. RUPA 404(b)(1) Meinhard v. Salmon V. Van Gorkom Factors pointing to breach of duty of care VI. Duties and responsibilities of directors a. Francis VII. Factors that overcome expert advice in DOC claim a. P. 351?